What Does it Mean to Lease a Car?
Leasing a vehicle is a unique method of obtaining a vehicle. A lease allows greater flexibility than purchasing because the leasee is only responsible for the value of the car used.
This can be easily confused with a car loan. A car lease does not necessarily end with vehicle ownership, a car loan does. A loan only applies to individuals who want to begin ownership from day one. When a loan is made the driver owns the vehicle on day one. It’s simply a method of paying off the vehicle.
A lease, on the other hand, only consists of monthly payments over an agreed upon time, usually 2-5 years. The only payments made during a lease agreement is the monthly fee and the potential costs of violating the lease agreement. Monthly payments are made until the lease ends. Once the lease ends, there may be costs considering whether or not you maintained the agreed upon terms of the lease.
The terms of the agreement include how many miles were driven, damage, and general wear and tear. If you exceed the agreed-upon terms regarding these specifics, you may incur a penalty that you must pay at lease’s end. Keep in mind, most lease agreements allow the leasee to purchase the vehicle as it is, this is called a buyout.
What Happens When The Lease Ends
The majority of leases includes an option to buy, this is called a “buyout.” A buyout means the leasee has the option to own the vehicle once the lease ends. However this does not apply to every car lease, take care to review the lease agreement to ensure a buyout is included. If you choose to continue leasing, here’s what to expect. The vehicle you leased will be checked for:
- The number of miles you have driven
- The interior and exterior of the vehicle
- A determination on the wear and tear inflicted on the vehicle
- The timing of your return, whether it’s early or late on time with the contract
- A deduction based on the residual value of the vehicle
All of these factors combined will determine if you need to pay the bank or lease provider and additional fees. At the beginning of the lease, you make an agreement to keep the car in good condition and to not exceed the agreed upon mileage.
Residual value describes the future value of a good in terms of absolute value in monetary terms and it is sometimes abbreviated into a percentage of the initial price when the item was new. In effect, you only pay the “value” of the car that you use. You then get a return based on the value of the car that remains after use.
Buying Your Lease
At the end of your lease, you may be conflicted about whether or not to buy the car you have been leasing. Let’s say you lease a car and end up really liking it. You’ve driven it for years and you no longer feel like trading it in for something new. Buying your leased car is called a buyout and it works just like any other purchase. You simply need to provide cash or get a loan. Once you make the payment, you simply get to continue driving the car.
You need to consider a few things before deciding to buy out your lease. Here are some things to consider when making a determination:
Price to Buy Is Less than Market Value
If the residual value is low, you can buy the car for less than it’s worth at lease end. Leasing companies have to resell their returned cars either directly to a dealer or through an auction. Often they will negotiate a buyout price that’s more favorable to you to avoid that hassle and expense.
By the end of your term, you may have accrued significant penalties. Driving over miles, excessive wear, and a collection of dings and dents can result in a hefty penalty. Depending on the remaining value of the vehicle vs your remaining penalty balance, it may be wise to simply buyout.
Consider all options before making a purchase under these circumstances. It may hurt to pay close to the value of the lease in penalties, but you don’t want to end up with a car you don’t want long term. However, if you enjoy the vehicle, this option could be a no brainer.
Determine the Value of Your Car
Even without heavy penalties on your vehicle, it may still be worthwhile to go through with the buyout. Consider the make and model of your car. Perhaps it didn’t go down in value as you predicted. Maybe it is more durable and comfortable to drive than another car in its price range.
Either way, you will need to either make a buyout, buy another car, or lease another car. Considering the complexity of calculating the value of a vehicle, it is definitely worthwhile to consult a professional to help you break down the math. Here is an example of what you can expect.
The Math of Leasing A Car
Now Let’s get into the nitty-gritty.
Consider a new Honda Accord which has a negotiated price of $26,000, remember that when leasing a car one of the most important factors is the “net cap cost” or the net selling price of the vehicle also known as the negotiated price. We’ll look into an example dealing with a 3-year loan and a 3-year leaser. Assume car will be worth 50% of the original value, or $13,000 regardless of whether we lease or buy, after 3 years of use. Set the finance rate for the lease and lean 5.0% APR and let’s see what we get. We’ll assume no down payment for either.
First, we’ll figure out the loan. Using an auto loan calculator, for a 3-year term, monthly payments will come out to $779.24. Total finance costs will be $2052.76, making the total cost (ignoring fees) of our purchase $28,052. Not too bad. Selling or trading the Honda Accord in 3 years (assuming normal mileage and wear), we’ll recover $13,000, losing $15,052 to depreciation and finance charges. Our total cost is, therefore, $15,052.
Second, let’s consider the lease. Use the same numbers except add a $595 acquisition fee to our cost. Also, tack on the usual $350 disposition fee which is charged when at lease-end. We’ll again assume normal mileage and wear, therefore no other lease-end charges. Using a lease calculator again, our monthly payments come to $460.13. Total lease cost will be the sum of payments over 36 months, $15,565, plus $350 disposition fee, for a total cost of $16,915. Total finance cost is $2993.
When calculating a lease, we use “money factor” instead of interest rate, but the conversion is easy: divide the interest rate by 2400. Therefore our 5.0% APR interest rate becomes .0021 lease money factor. Residual value is simply the expected lease-end value of the vehicle, $13,000, after depreciation.
Finally, we must consider the sales tax. Sales tax is paid on purchased vehicles and leased vehicles. This tax will vary based on state. We’ll assume a local tax rate of 6.0%. For a $26,000 vehicle the tax for a purchase is $26,000 x .06 = $1560. For a lease, the tax is applied to each monthly payment ($460.13 in our example). So, $460.13 x .06 x 36 months = $993.
When To Lease
As you can see, there are many benefits to leasing a car instead of buying. With a lease, you have the ability to have low monthly payments with the freedom to change vehicles every few years. Having a lease lets you spend time with a vehicle, really getting to know every single detail over the course of a few years. This is really the only way to truly know if you want to go through with the long term commitment to making a purchase.
A lease is especially helpful if you are not willing to drop a lump sum of money on a car. The low monthly payments and mileage restrictions can be very beneficial to someone who already knows that their average mileage comes below the lease agreement.
One of the most frustrating things a car owner has to deal with is car repairs. They can vary from common to bizarre and there’s no way of knowing which you’re going to get. There is a specific term that refers to a vehicle prone to odd problems, they’re called “lemons.”
Getting stuck with a lemon can be a nightmare. Suddenly you have thousands of dollars of repair bills that you weren’t expecting. Having a lease protects you from this kind of situation. Ultimately, you need to weigh the pros and cons of leasing for yourself. If you want to talk to a professional contact us at carvoy.com at any time.
When To Buy
Some people just know they want to own. They have always had a particular car in mind and now that they have the money they are ready to buy. There is nothing wrong with that approach, but not everybody has their heart seat on one particular vehicle.
Purchasing a vehicle also gives the buyer the opportunity to make modifications to it without worry about breaking the lease agreement. This is particularly helpful for those interested in making changes to the stock model of their car with aftermarket products.
Also, without a lease agreement, there is no limit to how many miles the owner can drive. This can be a welcome relief to those who drive a bit more than the average commuter. Perhaps you want to take a spontaneous cross country trip. No mileage agreement, no problem.
Finally, one of the perks of buying your vehicle is the ability to sell at any moment. However, cars and trucks famously lose value very quickly. Selling a car at the end of it’s life may grant the buyer a return on investment, but in no way can a vehicle be considered an asset.