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| Leasing: A guide | | Date Created: Jan 05, 2007, 11:22 AM |
How Leasing Works
Automobile leasing is based entirely on the concept that you pay for the amount by which a vehicle's value depreciates during the time you're driving it. Depreciation is the difference between a vehicle's original value and its value at lease-end (called residual value), and is the primary factor that determines the cost of leasing.
You are paying only for the value of the vehicle that you use. You are also only paying sales tax on that portion. This is where some of the savings comes from.
If you consider two cars, both costing $20,000 when new, where one is worth $15,000 after two years and the other worth only $12,000, the first car will cost less to lease because of it's smaller depreciation amount. Different makes and models of vehicles can have dramatically different depreciation rates. Those vehicles having the lowest depreciation make the best lease deals. The depreciation can be actual, or the amount of depreciation can be subsidized by the leasing company or car maker to intentionally lower the lease price.
Manufacturer's Suggested Retail Price - MSRP (Sticker Price)
MSRP is the price for a vehicle as displayed on its window sticker, including optional packages and destination charges. Dealer fees are not considered part of MSRP, although these charges are part of the overall cost of the vehicle.
Capitalized Cost
The price you pay for a leased car, this becomes the capitalized cost, or "cap cost." Cap cost is sometimes called lease price.
Capitalized cost may also include certain fees, such as an acquisition fee (similar to mortgage "points" , or loan origination fee). The acquisition fee is charged by the leasing company.
If you haven't fully paid off the vehicle you're trading, cap cost would also include any remaining loan balance ("negative equity") after trade-in credit is applied. Technically, you can not trade in a car towards a lease (in Michigan). You would be selling your vehicle to the dealer and then leasing a car. Two transactions.
Capitalized Cost Reduction
Capitalized cost (lease price) can be reduced by rebates, factory-to-dealer incentives, trade-in credit, or a cash down payment. These are known as cap cost reductions. Even modest cap cost reductions, such as a down payment, can create significantly smaller monthly lease payments, especially in shorter leases.
When you subtract cap cost reductions from cap cost, you get net capitalized cost, sometimes called adjusted cap cost.
How Residuals Affect Your Monthly Payment
The wholesale worth of a car at the end of its lease term, after it has depreciated, is called its residual value. The higher the residual value, the more the car is worth at lease-end ? and the lower your lease payments.
Since nobody can truly predict the future, residuals are only educated guesses based on historical resale-value data for specific automobile makes and models. Leasing companies subscribe to services that provide this kind of industry data, and then use it to set their own residual numbers.
Car manufacturers' leasing companies often temporarily boost residuals on slow selling vehicles or on vehicles that they want to emphasize so that they can offer better lease deals. These are subsidized deals.
Residuals are usually stated as a percentage of MSRP. A 36-month, 50% residual on a new $20,000 car means that its estimated depreciated value at the end of a 3 year lease will be $10,000. The actual value at the end of 36 months might be higher or lower.
Residual percentages decrease as the length of a lease, called the lease term, increases. This is because the older a vehicle gets, the less it's worth. For example, the 24-month residual on a particular car might be 57%, decreasing to 50% for 36 months, then to 44% for 48 months, and 39% for 60 months.
Residuals fall rapidly in the first 24 months, then more slowly in later months. This is why shorter term leases are more expensive than longer leases. Generally, residuals set by car manufacturers' finance companies are higher than industry averages to help promote lower lease payments.
Money Factor
When you lease, you're tying up the leasing company's money while you're driving their car. Remember, they spent their money to buy your car from the dealer so that they could lease it to you. They rightfully expect you to pay interest on that money, the same as with a loan.
This interest is expressed as a money factor, sometimes called lease factor or simply factor, and is specified as a small decimal number such as .00297.
Some recent manufacturers' lease deals have offered lease rates as low as .000625 or lower. However, you may not qualify for these money factors unless if you have a spotless, or near spotless, credit rating.
Credit requirements for leasing are somewhat more strict than for purchase loans because of higher risks to the financial company.
If your credit history is flawed, even if it's a mistake, you'll pay a higher interest rate ? or not be able to lease at all. It's always advisable to know your credit report and FICO score before visiting your dealer. If you spot problems, get them resolved with the credit reporting agency as soon as possible.
Lease Term
Lease term is the length of time a car is leased, usually expressed in number of months. Typical leases are 24, 27, or 36 months, although terms, such as 30, 39, and 42 months are seen in lease promotional ads.
Although longer leases produce somewhat lower monthly payments it may be smarter to choose a shorter lease term. Here's why.
Choose a lease term that's no longer than the general coverage warranty that comes with your vehicle. That way, you're covered for the entire duration of the lease if something breaks. For example, if a vehicle's "bumper-to-bumper" warranty is 36 months, don't lease for longer than 36 months.
Many major vehicle problems start in the fourth or fifth year. For this reason, 60 month leases, which are declining in popularity, are not recommended except for those few makes that have unusually long warranties (GM Product: 5 years/100,000 miles). |
Now we know the separate factors that contribute to the cost of car leasing: net cap cost, cap cost reductions, residual, money factor, and term. Now, let's put it all together and see how your monthly lease payment is determined.
Monthly Lease Payment Formula
A lease payment is made up of three parts: a depreciation fee, a finance fee, and sales tax - all added together. We'll look at the first two parts of the formula below.
Depreciation Fee
The depreciation fee portion of your payment simply pays the leasing company for the loss in value of its car, spread over the term (number of months) of the lease, based on the miles you intend to drive and the time you intend to keep the car. You pay off an equal portion of the total expected depreciation each month. This is calculated as follows:
Depreciation Fee = ( Net Cap Cost ? Residual ) ÷ Term
Remember, Net Cap Cost is the Gross Cap Cost (selling price) plus any add-on fees and taxes, and any prior loan balances, minus any Cap Cost Reductions (down payment or rebates). A good lease deal is when you have the lowest possible Net Cap Cost with the highest possible Residual.
Finance Fee
The finance fee portion of your monthly lease payment is like interest on a loan and pays the leasing company for the use of their money. It's calculated as follows:
Finance Fee = ( Net Cap Cost + Residual ) × Money Factor
Yes, you add Net Cap Cost and Residual ? this is not a mistake. It's not double-counting as it may appear. It's simply a way of calculating the average amount financed without using complicated constant-yield annuity business formulas.
Also be aware that you're paying finance charges on both the depreciation and residual (since you're tying up this amount of the leasing company's money while you're driving their car). Technically, you're paying finance charges on half the depreciation and all of the residual for the term of the lease.
Total Monthly Payment
Now, add the Depreciation Fee and the Finance Fee that you calculated above to get your Total Monthly Payment.
Sales tax must also be added.
Total Monthly Payment = Depreciation Fee + Finance Fee
Note: Ford Motor Credit (FMC) uses a slightly different, more complex formula than the rest of the world, which results in slightly higher payments ? typically 2%-3% higher than the figure you get using the conventional formula above.
Example Calculation Using the Leasing Formula
So now that we've looked at the formula, let's see how it actually works.
Let's assume you've decided on 3-year (36 month term) lease of a Chevrolet Impala that has a sticker price of $24,600.
You've managed to negotiate the price down to $24,000 (Cap Cost). You decide not to make a down payment, but you have a trade-in worth $6000. Your Net Cap Cost is therefore $24,000 - $6000 = $18,000.
Now, the dealer tells you that the Money Factor is .00375 and the Residual Percentage is 60% of MSRP. So your Residual amount, in dollars, is .60 x $24,600 = $14,760.
Now let's do the math:
Depreciation Fee = ( $18,000 ? $14,760 ) ÷ 36 = $90
Finance Fee = ( $18,000 + $14,760 ) × .00375 = $122
Monthly Lease Payment = $90.00 + $122.85 =$212.85 (plus sales tax) |
In car leasing there can be charges, fees, and taxes that may surprise newcomers. These can differ by leasing company and by the state in which you lease. The same charge or fee can sometimes have different names in different lease contracts.
Let's take a look at the most common types of charges, fees, and taxes:
First Payment
A lease is different than a loan in that payments are made at the beginning of the month in which they're due, while loan payments are paid at the end of the due month. This means you make your first lease payment in cash at the time you sign the contract. The first payment is NOT considered a down payment or a security deposit.
Security Deposit
A fee that is usually about the same amount, or a little more, than your monthly payment. It will be refunded to you at lease-end, less any disposition, mileage, or damage charges. If you have a good credit rating or are a repeat leasee you may not have to make a security deposit. The leasing company determines this. Making a security deposit is not the same as a down payment, which you don't get back at the end of your lease.
Acquisition Fee (Bank Fee)
An acquisition fee, sometimes called a "bank fee," is an administration fee charged by the leasing company, much like points on a mortgage. This fee is usually not explicitly specified in your contract, but is included in your Cap Cost when calculating monthly payments. This fee is typically in the range of $250 to $900, depending on the lease company.
Disposition Fee
A typical fee, set by the lease company, that is due at the end of the lease to compensate the leasing company for the expenses of selling or otherwise disposing of the vehicle. Some leasing companies might also require this fee even if you decide to purchase your vehicle at the end of the lease. $250 to $450 is typical for this fee, if the fee is charged at all. Some lease companies do not charge a disposition fee. This is becoming rare, as it pops up as a surprise at the end of the lease, when the lease company is trying to keep you as a loyal customer.
Tax on Down Payment
If you make a down payment (capitalized cost reduction) on your lease, you will be charged state sales tax on the down payment amount in most states and in Canada. It is payable at the time you sign your lease contract.
Documentation, Registration, License, and Title Fees
These are the same fees you would normally expect to pay in your state whether you lease or buy your new car.
When are fees and taxes paid?
When a lease contract is signed, there are certain fees, taxes, and charges due as up front cash. These include the first month's payment, any down payment, sales tax on the down payment, any security deposit, and official state/county license/tag/registration fees. The total of all these fees are usually called "lease inception" fees.
Notice that any down payment amount is only a part of the total lease inception amount. This sometimes confuses leasing consumers who mistakenly think of the total inception amount as a down payment.
The acquisition fee can be included in the capitalized cost and is financed along with the lease. It is not always paid up front in cash.
The disposition fee is collected at the end of the lease when a vehicle is returned to the lease company and, in some cases, when the vehicle is purchased. Some states charge sales tax on the disposition fee.
Security deposits are returned by the lease company at the end of a lease.
Sales Taxes
U.S. states (except New Hampshire, Alaska, and Oregon) and Canada impose a sales tax on motor vehicle purchases by consumers. In the case of leasing, the leasing company passes the sales tax along to you, the lessee. However, the way it's done can be quite different from state to state, even region to region.
The most common method is to tax the monthly lease payment at the local sales tax rate. This means you only pay tax on the part of the car you lease, not the entire value of the car. For example, if your local sales tax rate is 5%, simply multiply your monthly lease payment by 5% and add it to the payment amount to get your total payment figure.
In some states, such as Ohio, you pay sales tax up front on the capitalized lease cost. In other states, such as Texas and Illinois, you actually pay sales tax on the full value of the leased car, not just the leased value, just as if you were buying it. In Illinois, you can also pay monthly taxes.
Before you lease, you should ask your dealer or your state taxing authority how sales taxes are applied, and by how much, in your area. Tax laws change frequently.
Generally, you pay sales taxes for the locality in which you live, not for the locality in which the car dealer has his showroom. |
Auto Lease Contracts
Auto lease contracts are all slightly different in detail, but contain important common elements that should become familiar to you.
Lets' look at some of the key elements of a typical auto lease contract.
Disclosure Statement
Regulation M
In January 1998, the Federal Consumer Leasing Act, Regulation M, was revised to require that certain key information and figures are in every lease contract. It required that Capitalized Cost, Capitalized Cost Reduction, Residual Value, Lease Charges, Monthly Payments, and other amounts be clearly spelled out. It also required that this information be displayed in a uniform way, and using standard terminology.
Federal law requires that lease contracts contain a section in which certain facts and figures are disclosed to you. This section in your contract is often titled, "FEDERAL CONSUMER LEASING ACT DISCLOSURES." The following sections are among those required:
? Amount due at signing
? Monthly payment
? Other charges
? Total of payments
? Amount due at lease signing
? How monthly payment is determined
? Early termination statement
? Wear and tear explanation
Insurance
Most auto lease agreements require you to maintain insurance coverage: bodily injury or death liability: $100,000 per person / $300,000 per occurrence, property damage liability: $50,000, comprehensive and collision for actual value with no more than $500 deductible.
While this may be more coverage than you might buy normally, it's always smart to have maximum protection in these times of expensive repairs and huge lawsuits, regardless of whether you're leasing or buying.
Excessive Wear and Tear
Leasing contracts specify that you must return the car at lease-end with no more than "normal" wear and tear. Most new contracts do a pretty good job of spelling out exactly what "normal" means. Basically, it means you have to take reasonably good care of the car and keep it maintained.
It's interesting that this is the part of the leasing contract that is most responsible for "leasing phobia" with many first-time leasers, and causes some people to decide not to lease. These people have a tremendous unfounded fear that, when they return the car, the leasing company will examine it with a fine-tooth comb and penalize them thousands of dollars for minor dings and scrapes.
Of course, if you actually have significant damage, seriously worn tires, and deep scratches, you should get them repaired before your return the car ? or pay MORE after you return the car.
Excessive Mileage
Leasing agreements specify the maximum average annual mileage you're allowed without paying a penalty. The most common mileage limit is 15,000 miles per year, although 10,000 or 12,000 miles are often used.
Make sure that when you lease, you select the limit that best fits your driving needs because the penalty at lease-end for exceeding the limit can be expensive ? typically in the range of $0.15-$0.25 per mile.
Early Termination
Terminating a lease contract early can be costly. Many people seem to think that because getting into a lease is so easy, that getting out must be easy too. Actually many lease agreements won't let you get out until you've leased for a certain amount of time, usually 12 months. After that time, there are provisions for terminating.
To summarize, if you think there's a possibility that you will not be able to complete your lease term agreement, it's best not to lease!
If you're already in a lease and need to end it early, there are options available to you that may allow you to eliminate or minimize your early termination costs.
Destroyed or Stolen Vehicle
Having your leased vehicle totally destroyed or stolen is a form of early termination and, unless you have gap protection, you are exposed to the same penalties and payments as described above. Gap protection, sometimes called gap insurance, covers any additional amount that you might owe after your insurance company pays off.
Gap coverage is included in most modern lease contracts. In a few, it's offered as an option ? for a fee. |
After You've Signed the Deal
Signing the lease contract is only the beginning of your lease. After the signing, your contract is turned over to the leasing company. From this time on, any concerns or questions about your lease should be directed to the leasing company, not your dealer. Go to your dealer only for issues related to your vehicle (warranty repairs, recalls, etc.)
It's possible that, during your lease, you may receive notification that another leasing company has "bought" your lease. This should cause you no concern because your original contract still applies. Your payments will not change.
If you absolutely must terminate your lease, the later you can wait, the better.
Careful about moving your leased car
If you plan to move during the time of your lease, be aware that many lease contracts may restrict you in some way. Most prohibit moving their vehicles out of the country.
If you are permitted to move your vehicle out of state (which is typically not a problem), your payments could change slightly due to different sales tax rates between the states. Always notify your lease company when you move so that they can make the adjustments.
Hold up your part of the contract
Make sure you maintain your vehicle, keep the contract-specified amount of insurance, and make your payments promptly. Purchase tags, registrations, and pay taxes as required by your local government. Don't make modifications to your vehicle, or fail to repair any damages. Don't use the vehicle for illegal purposes, drive while intoxicated, or let unlicensed drivers use it. Pay all fines and fees associated with the vehicle. Failure to do these things is a violation of your lease contract.
It's best to maintain your vehicle according to the schedule in your vehicle's owner's manual.
About insurance coverage
All lease contracts require that you carry insurance on the vehicle, naming the lease company as "additional insured." The level of coverage required may be more than you might otherwise carry on a vehicle of your own. Not to carry the specified amount of coverage is a violation of your contract. Typically, the amount of coverage is as follows:
? Bodily Injury - not less than $100,000/$300,000 (single/multiple people)
? Property Damage - not less than $50,000
? or Combined Bodily Injury/Property Damage - no less than $500,000 per accident
? Deductibles - no more than $1000 for collision, no more than $1000 for comprehensive
In case of an accident, theft, or loss; you should immediately notify both the insurance company and the lease company. If the accident causes repairable damages, your insurance will pay for the repair of those damages, minus your deductible. Be sure to have the repairs done by a reputable shop that does quality work and uses "original equipment manufacturer" (OEM) parts. Otherwise, you may have to pay for the repairs to be done correctly when you return your vehicle to the lease company at lease-end.
If your vehicle is totally destroyed or stolen, the insurance company pays the lease company for the vehicle (remember, the vehicle belongs to them), minus the deductible, which you have to pay. The insurance only covers the current value of the vehicle, not the amount you still owe on your lease, which may be more. Unless you have gap insurance, or your lease contract specifically lets you off the hook, you have to pay the difference ? possibly a large amount. Some lease contracts have a waiver clause that lets you off ? but check yours to make sure.
Some states now have "diminished value" laws that require your insurance company to compensate vehicle owners for the lower resale value of the vehicle if it's been in an accident, even after repairs have been made. This payment should go to the lease company.
Watch your mileage
During your lease keep a watch on your mileage so that you won't exceed your limit by the time your lease ends. If you have a 12,000 mile annual limit, for example, you should be driving no more than 1000 miles per month, on average.
If you find that you're driving too many miles, try to take action to bring it back in line. You could try swapping vehicles for a while with someone who doesn't drive as much as you do. Or you could rent a vehicle to drive on vacation, rather than drive your leased vehicle. Or carpool to work. Or consolidate multiple short trips into one.
If you simply cannot stay within your mileage limits, just realize that automobile mileage is not free, regardless of whether you're leasing, buying, or renting. It's best to simply acknowledge that you have to pay for the miles, and begin putting money aside for the eventual lease-end payment. Of course, if you decide to purchase your vehicle at lease-end, you avoid mileage fees altogether.
Leasing is good
For most people, leasing is a problem-free, moneysaving, and enjoyable experience that returns them to lease again with their next car. Many people who are leasing today have been happily leasing for many years.
People who have problems with leasing are generally those who didn't understand how leasing works before they leased, or simply were not good leasing candidates (e.g., drive dramatically varying miles every year). These people generally attribute their bad experience to the fact that, in their view, leasing is a scam or is a terrible way to finance. |
Lease End
It's never too soon to be thinking about the end of your lease. Many people who know they should do some homework and prepare for the beginning of a lease overlook the need to also prepare for the end of the lease as the time nears.
Get Out of Your Lease Early
To end your lease before its normal termination date could be costly unless done correctly. You can simply return your car and walk away if there is a "pull ahead" program available on the vehicle. Sometimes a dealer will help make your final payments in order to earn your business on the next vehicle.
You have a number of possible options, but choosing the right option for your particular situation requires a little homework. Choosing the right option also protects your credit history.
Your lease-end options
At the normal end of a lease, you may have the following options: return your vehicle, extend your lease, re-lease, purchase, or trade.
Depending on the details of your particular lease situation, some of these options may be available to you while others will not be.
How it works
Before the end of your lease, you will be contacted by your leasing company. They will instruct you regarding having your vehicle inspected and returned to them. Normally, the return is made to a dealer, from which the lease company will pick up the vehicle.
They may also remind you of your option to purchase your vehicle and provide you a purchase buyout price. They may also offer to extend your lease for specified terms. They won't tell you, but you may also be able to use your vehicle as a trade-in on a new purchase.
Be careful of your lease-end decision
Don't make a quick decision about which lease-end option you'll take. For example, if you simply return your vehicle to the lease company without doing your homework, you may be handing them built-in value that belongs to you. They'll love you for the gift.
But what if you have exceeded your mileage limits or have some damage to your vehicle? Is it best to return, or to purchase? Can the mileage and damage fees be negotiated if you decide to return?
Is extending your current lease or re-leasing a smart thing to do? When is it advisable to use your leased car as a trade-in? Do you still have to pay for excess mileage and wear-and-tear?
What to do
Answering the above questions and deciding what to do requires a little homework and careful consideration of all your options. Remember, it's just as important to make the right decisions at the end of a lease as it is at the beginning. But each situation is different and must be examined on its own merits. There is no standard answer that fits every case.
It may be best to visit your dealer and have the sales consultant go over the options with you. Remember, the sales consultant is there to sell you a car, but will usually be able to offer some advise as to the best way to do so. Under many circumstances, there is no pay for helping a customer buy out thier own lease, but the consultant will get a "mark" or "point" (credit for a car sale) for doing the work. |
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