By Philip Bachman
We posted articles about car shopping on April 14 and July 20. They discussed some overarching financial considerations about buying a car. Today’s article will discuss a question I hear often: what about leasing?
Auto leases are a different animal than auto loans, but they are not as mysterious as some think.
With a traditional car loan, you pay for a car including interest over a number of months. If you sell the car or trade it in before the term is up, you owe the lender the payoff. This could result in either a negative or positive equity situation based on the car’s market value at the time.
With a lease, you pay for the use of a car for a set number of months. The lessor (usually the auto manufacturer’s credit division) sets a fixed value for the car at the end of the term, called the residual value, which is paramount to calculating the lease. In other words, you pay for the depreciation of the car to a defined point, plus a finance fee called the money factor.
Assuming a closed-end lease, the type considered consumer-friendly that most leases are these days, you have the right to turn the car back in and owe nothing (walk away) at the end of the term. Many people start a new lease on a new car at that time. But you also have the right to keep the car by buying it for the residual amount or the market value (basically finish paying for the car).
A benefit to leases is the fact that the lessor guarantees what your car will be worth in the future by way of the residual value, removing the risk that you will become underwater in the car. If you abide by all the lease terms until the lease ends, you will not end up in a negative equity situation, as many do when trading in used cars with a loan. If you trade in your leased car before the term is up, there may be a payoff amount due, similar in concept to a loan payoff.
Leasing may be good for folks who:
1. enjoy having a new car every three years and who don’t plan to keep a car over three years (different term lengths may be available),
2. do not drive very much (for example 10,000-12,000 miles per year),
3. want a car that is always within the manufacturer’s warranty, or
4. want a lower monthly payment than a loan. The monthly payments tend to be lower with a lease than a loan because the value that is divided up is not the whole car; it is only part of it.
Leasing is not good for people who:
1. keep cars until the wheels fall off,
2. drive a lot, customize their vehicle a lot, or drive it aggressively like off-roading,
3. are ok if their car is not within the manufacturer’s warranty, or
4. prefer to own their car outright.
Some folks are hesitant to talk about leasing, claiming they never own their car in a lease. That is technically true. But you do not completely own your car in a traditional loan either until you pay the loan off.
Leasing is more popular today than ever, with 33.6% of new car and truck sales in the last three months of 2015 being leases, according to the Detroit Free Press (03/03/2016). In addition, the previously-uncommon practice of used car leasing is becoming more widespread, according to the Wall Street Journal (04/11/2016).
There is much more to leasing than can be covered here, but hopefully this article is a helpful introduction.