Buying or Leasing a Car

Leasing has become an increasingly popular way to obtain a new car. It is estimated that at least 33% of 1997's new car sales will be leases. 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. However, leasing an automobile is a complicated transaction that can be cost effective for certain drivers and excessively costly for others.

What are your options for paying for a new car?

The majority of consumers are familiar with the practice of buying a new car. This involves either paying for the entire cost of the car upon delivery, or making a down payment followed by monthly payments. When you finish paying for the automobile, you will own it. Many people enjoy the feeling of security and freedom that ownership provides; you may do what you please with the car. A lease, however, is a different way to acquire a new car. Dealers increasingly offer leases as an option to buying. In fact, dealers have been known to misrepresent leases as "special financing offers" to consumers who really wanted to buy a car. Leasing is a concept that is misunderstood by many consumers who are shopping for a car. Knowledge about the advantages and disadvantages of leasing can be useful no matter how you plan to finance a new car.

What is leasing?

An auto lease is a financing agreement where the consumer pays for the use of a 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 overtime, 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, starting 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 also now required.

What kinds of leases are there?

There are two basic kinds of leases. On open 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. These types of leases should be approached with caution. The most common is the "closed" lease. With this kind of lease all of the payments, the residual value of the car is preset, and you are not responsible for the actual market value of the car at the end of the lease.

Items to be wary of in leasing agreements:

Capitalized cost reduction
Leasing companies will tout extremely low monthly rates in advertisements while downplaying the fact that to obtain these rates, a large down payment called a capitalized cost reduction is required. Beware of advertised low monthly payments because they may require this payment. If you are considering a lease to avoid the large down payment associated with buying a car, this is probably not the best lease for you.

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. If you feel these charges are too high or unwarranted you can dispute them through the New York State Attorney General's office.

Mileage fees
Most leases have a mileage cap of 12,000-18,000 miles per 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.

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.

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.

Disposition fees
This is a fee totransport the car to a dealer if you not to purchase it at the lease end. 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 that excess mileage might 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 time period. 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 background 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 at 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 number 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.

Contact the Better Business Bureau to check out the firm's reliability before you negotiate with any automobile dealer or leasing company. Consumers who wish to file a complaint against an auto dealer, or receive a dealer's Reliability Rating can contact the Bureau at 412-456-2700. Consumers can also write to the Bureau at 400 Holiday Drive, Pittsburgh, PA 15220, or access the Bureau's web site at Consumers with leasing disputes can submit to binding arbitration through the Comsumer Protection Department in Attorney General's Office. For more information, contact them at 800-441-2555.