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The Beginner's Guide to Leasing

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For those considering a lease for the first time, it can be confusing to understand all of the elements that make up a lease and still feel confident that they are getting a great deal.

At Cartelligent we help thousands of clients each year choose the best financing options for their personal circumstances. This guide is intended to help clarify the decision to buy or lease. 

As a general rule, purchasing is preferred by consumers who want to keep the same car for a significant number of years. In contrast, leasing is intended for consumers who would rather drive a newer car or would like a lower monthly payment than they can get by financing.

While most car buyers have a basic understanding of the concept of purchasing and financing a vehicle, leasing is almost intentionally confusing. Consumers who are new to leasing will often focus on their monthly payment or the selling price of the vehicle. This can make it easy to miss other factors that affect their total cost such as the upfront costs of the lease, the interest rate being paid and any unapplied rebates and other incentives.

In addition, leasing comes with its own jargon and obfuscations. We’ve defined some of the more common terms below:

  • Capitalized (Cap) Cost: The negotiated price for the vehicle
  • Residual Value: The amount the vehicle will be worth at the end of the lease term
  • Money Factor: The interest rate of the lease (this can be converted to the more familiar APR by multiplying it by 2400)
  • Cap Cost Reduction: Any payment made upfront to reduce the monthly payments (the equivalent of a down payment)
  • Acquisition Fee (or Bank Fee): A fee charged by the financial institution underwriting the lease which is included on all leases

 

How to understand leasing

The basic concept behind leasing is that you only pay for the portion of the car’s lifetime that you intend to use. Consider the example of a car with a negotiated price, or cap cost, of $47,000 today and an estimated residual value of $28,000 three years from now. In a lease, you are only paying for the $19,000 difference between the two values rather than the full negotiated price of $47,000 (plus interest, taxes and fees in both cases). Additionally, in a lease, sales tax is only applied to that $19,000 difference rather than the full price (which would be the case if the vehicle were purchased). At a tax rate of 9.0%, this results in a net savings of $2,520 in this example. (For the purchase, $47,000 x 9% = $4,230; for the lease, $19,000 x 9% = $1,710; $4,230 - $1,710 = $2,520).

This can result in a considerably lower monthly payment for the lease. Assuming $2,500 in upfront costs and an APR of 2.9% in both cases, the car above will lease for around $700/month including tax (over 36 months) while the purchase will cost approximately $900/month including tax (over 60 months). That’s a difference of $200/month or $2,400/year to drive the same car. Also, manufacturers will often incentivize leases with rebates and/or lower interest rates that can reduce the monthly payment further. For example, a $1,500 rebate would reduce the lease payment in this example to around $650/month. This increases the savings on monthly payments to $3,000/year or $9,000 over a typical three year lease.

Other than the lower monthly payment, the major benefit to leasing is that it allows you to consistently drive a newer model vehicle. There are a number of significant advantages that this offers:

  • Safety: Auto manufacturers are regularly updating their vehicles with new and innovative features that can make driving safer. Driving a more recent model ensures that you and your family are protected by the best safety devices currently available.
  • Fuel Economy: According to the University of Michigan Transportation Research Institute, the fuel efficiency of the average US vehicle rose fully 1 mpg from 2012 to 2013. Steady annual increases in fuel economy can result in significant savings at the pump for newer models.
  • Maintenance: A newer car is always under warranty which means that there are never unexpected repair bills. Additionally, you have the added peace of mind that the vehicle is less likely to break down due to normal wear and tear.
  • Technology: Innovations like Bluetooth, Pandora radio and in-vehicle apps can make driving a newer car both safer and more enjoyable.

 

Of course there’s a caveat to leasing. After the lease term is over you do not own the vehicle and will need to either return it or purchase it at the residual value. (For more on the lease return process see Preparing to turn in your leased car)

Which decision is right?

We've focused primarily on leasing for this guide because it is generally more misunderstood by consumers. There are advantages to both leasing and purchasing depending on your personal circumstances. We’ve put together a list of the benefits of each to help you weigh your options. (For more on our most leased brands see Which car brands do people lease or buy?

 

Benefits to Leasing: Benefits to Purchasing:
  • Opportunity to drive a consistently newer car with the latest safety, technology and fuel efficiency
  • Own vehicle outright once loan is paid in full
  • Lower monthly payment for same vehicle; often lease-only incentives
  • Can be less expensive over many years of ownership
  • No unexpected repair costs 
  • Don’t have to worry about going over mileage limits
  • Don’t have to deal with hassle of eventually selling vehicle 
  • Don’t have to worry about costs of damage or wear and tear to vehicle
  • Can be expensed for business
 
  • Can be a good way to try a new vehicle without a longer term commitment
 

 

Need more personal guidance? The car-buying experts at Cartelligent can walk you through your financial options and help you make an educated decision. Your initial consultation is always free and there is never any obligation to use our services. For more information, give us a call at 888-427-4270 or get started today.