Educational Consumer Tips
Author: Better Business Bureau
Leasing an automobile has become an increasingly popular way to obtain a new car. With the attraction of low down payments and low monthly payments, people are considering leasing automobiles they do not think they can afford to purchase.
WHAT IS LEASING?
An auto lease is a financing agreement where the consumer pays for the use of new automobile over a set period of time. The car is owned by the leasing company, which can be a bank, the auto dealer, or an independent company, who sets a financing rate for the term of the lease. At the end of the term, the car is returned to the leasing company, unless there is an option to buy in your leasing agreement.
HOW ARE LEASE PAYMENTS DETERMINED?
Unlike some assets that appreciate over time, a car's value diminishes as it gets older. When you lease a car, you are paying for the depreciation of the automobile over the period of the lease. The original selling price is called the capitalization cost. The residual is the projected worth of the car at the end of the lease. The difference between these figures, which is the overall depreciation, is the basis for determining your monthly payment. The depreciation per month is added to your finance rate, or money factor, to figure out your total monthly payment. In an effort to make it easier for consumers to know exactly what they are paying for, as of October 1, 1997 auto leasing companies are required to thoroughly disclose costs to be paid at the lease signing. Leasing companies must also disclose the total amount of payments, to make comparisons between leases easier. Warnings about the penalties for early termination and clearer statements of how lease payments are calculated are now also required.
WHAT KINDS OF LEASES ARE THERE?
There are two basic kinds of leases: the closed-end lease and the open-end lease. The majority of consumer leases are closed-end. At the end of both types of leases, you may return the leased vehicle. With a closed-end lease, the residual value-or the vehicle's guaranteed future minimum value-is determined at the beginning of the lease. In other words, you are not responsible for the actual market value of the car at the end of the lease. In an open-end lease, the leasing company estimates the market value of the car at lease end. This estimate becomes the basis of the monthly payments. If the actual value of the car when the lease expires is lower than the estimated value, the consumer is required to make up the difference.
TERMS TO BE AWARE OF:
1) CAPITALIZED COST REDUCTION- Leasing companies will tout extremely low monthly rates in advertisements while downplaying the fact that to obtain these rates, a large downpayment called a capitalized cost reduction is required. Beware of advertised low monthly payments because they may require this payment. If ytou are considering a lease to avoid the large downpayment associated with buying a car, this is probably not the best lease for you.
2) EXCESS WEAR CHARGES- You are required to return the car to the leasing company in good condition. If the leasing company feels you have subjected the car to a higher than normal amount of wear and tear (rips or stains in the interior, dents) they may bill you for the damages.
3) MILEAGE FEES- Most leases have a mileage cap of 12,000 to 18,000 miles pe r year. If you choose to lease and drive more than your mileage limit allows, it is generally cheaper to pay the anticipated excess mileage fee in advance. Excess mileage packages are often available with a lease.
4) EARLY TERMINATION CHARGES- Leases are notoriously expensive to end early. Early termination fees have been known to exceed the original price of the car, so read your lease agreement carefully to find out what the terms for early termination are.
5) INFLATED CAPITALIZED COST- Capitalized cost is the negotiated value of the car. The lower the capitalized cost the lower the cost of the lease. When shopping for a lease, be sure to negotiate the capitalization cost just as you would if you were buying the car.
6) DISPOSITION FEES- This is a fee to transport the car if you do not purchase it at the end of the lease. Beware of this clause often hidden in leasing agreements.
IS LEASING RIGHT FOR YOU?
Something to consider when acquiring a new car is how much each mile will cost you for the life of your car. If you would be satisfied with the same car for 10 years and 200,000 miles, then owning the car would make sense because your cost per mile would be very low. However, most people do not keep a purchased car for that long, or get that kind of usage out of it. A lease agreement could be desirable for people who meet several of the following conditions:
1) Drive less than 12,000 miles per year. Remember that your lease probably has a cap of 12,000-18,000 miles per year, and excess mileage may make ownership a less expensive option.
2) Like to have a new car about every two to five years. If you would buy a new car after a few years, leasing is a good option because you are simply paying for the use of the car over that period of time. You also do not have to worry about selling or trading in the automobile at the end of the lease as you would if you owned the car. Your lease term should be the length of time you think you will want to drive the car. As a general rule, the longer the lease, the lower your monthly payments will be.
3) Are self-employed or own a business. An advantage of a lease is that if the car is used entirely for business, you can deduct all of your lease payments from your taxable income (partial business use would be deductible at a lower percentage). If you were to purchase the same car, you could deduct the depreciation only according to an IRS schedule. These schedules allow a deduction for depreciation that can be a lower rate than the car actually depreciates. Maintenance and upkeep are deductible as business expenses no matter how you finance the car.
4) Don't have much money for a down payment. Unless your lease includes a capitalized cost reduction, your initial investment should be fairly minimal--usually the first month's payment, tax and registration fees, and a refundable security deposit. However your credit backround is checked extensively when you apply for a lease. A spotty credit history will usually disqualify you from a lease agreement. Some people choose to pay a down payment since it lowers your monthly payments by reducing the capitalization cost of the lease.
WHAT ABOUT INSURANCE?
The right insurance is very important when you lease an automobile or else you could be stuck with the cost of the lease and the residual if the car is stolen or a total loss in an accident. You should seriously consider investing in gap insurance . Gap insurance covers the rest of the lease and the residual cost of the car in case of a total loss. Standard insurance is also necessary since you are responsible for repairs and maintenance while you are driving the car.
A FINAL NOTE
Look at more than just the low monthly payments before entering into a lease. Make sure you have considered all of the fees and stipulations described above, and figure out what the lease would really cost you per month. Leasing companies are required by law to disclose in TV and print advertising all required fees and payments, as well as the type of lease it is. Some ads now refer consumers to a toll free or printed ad for complete details on a lease. Be sure to obtain a statement of figures from the leasing company to see how your base monthly payments were determined. This will show you the capitalization cost, residual and money factor.