Understanding leasing: Frequently asked questions
Leasing is becoming an increasingly popular option for many car buyers. However, the specific jargon and conditions of leasing can make potentially confusing, especially for first time lessees.
At Cartelligent, we help thousands of clients each year make the decision to lease or buy. In this article, we answer the questions we're most often asked by clients who are thinking about leasing.
Can leasing a car be a better deal than buying?
Depending on which brand you want and how long you intend to keep it, leasing can be more cost effective than buying the vehicle outright. As a rule of thumb, if you plan to drive the vehicle for fewer than six years, two three year leases are generally more cost-effective than buying the vehicle outright and selling it at the end of the term. For specific examples, check out our Buy vs. Lease series of articles.
What is the difference between a money factor and an APR?
Most people are familiar with the annual percentage rate (or APR) which is the annualized rate at which interest accrues on a loan. The money factor on a lease is the same basic concept only expressed in a different (and arguably more confusing) manner. The money factor is simply the APR on a lease divided by 2400. In order to convert money factor into the more understandable APR, simply reverse this and multiply by 2400. (A 0.00125 money factor multiplied by 2400 becomes a 3.0% APR.)
How do residual values work?
The residual value is, in essence, a pre-arranged price that the manufacturer thinks the car will be worth at the end of the lease. Instead of buying the car at the full purchase price and selling it three years later, the residual value is subtracted from the negotiated price of the vehicle and you pay this amount (plus interest and fees) spread out into monthly payments. This means that you’re only paying for the value the car loses during the period of time you will be driving it.
How is a cap cost reduction different from a down payment?
This is another bit of leasing jargon that can be confusing to first time lessees. The capitalized cost, or cap cost, is the total amount being financed with a lease. This includes the negotiated cost of the vehicle, as well as any taxes or fees that are being financed.
A cap cost reduction, therefore, is any payments, rebates, or trade-in credits, paid up front that lower the amount being financed. Like a down payment, the greater the cap cost reduction, the lower the monthly payments will be.
How is sales tax applied to a lease?
Sales tax is only applied to the payments you make over the term of the lease. This can significantly reduce the amount of sales tax you pay as compared to financing, and as a result, the monthly payments.
Which parts of a lease are negotiable?
Of the three factors that contribute to the cost of a lease, only the price of the vehicle and the money factor are negotiable. The third factor, the residual value, is set by the manufacturer and is not open to negotiation.
How should I determine what mileage to include in the lease?
Typically a lease comes with a set number of miles that the vehicle can be driven before additional fees are applied. This is usually 10,000, 12,000 or 15,000 miles per year, but if you think you will go over this it can be a good idea to purchase additional miles in advance. To get an idea of how many miles you use, take your round trip daily commute to work and multiply it by 260. You probably do some additional driving on the weekends so add another 10 to 20%. If you’re close to or over the allotted mileage, you may want to purchase additional miles in advance so that you don’t run into overage fees at the end of the lease.
Remember that the manufacturer has essentially agreed to buy back the vehicle for the residual value. This value is based on assumptions such as the vehicle’s mileage and condition. If the vehicle is over mileage it is likely worth less than the residual value and the manufacturer will need to be compensated via overage fees for that difference.
What is the shortest car lease available?
Typically car leases are for 36 months, but they can be as short as 24 months. While it is possible to lease a vehicle for less than 24 months, the terms of such a lease are generally not favorable and we do not recommend them in most circumstances.
What if I want to end my lease early?
There is usually a fairly high early termination penalty on leases. However, if you’re approaching the end of your lease and you want to lease the same brand again, you can sometimes take advantage of a "pull ahead" program. These programs will often waive the last few lease payments on your old lease in order to get you into a new car before the lease is up.
What happens at the end of the lease?
Assuming that your vehicle is in good condition and you are under your allotted miles, all you need to do is return the vehicle to any dealership and pay the disposition fee (most brands will waive this if you lease another vehicle with them). For more on lease end see Preparing to turn in your leased car.