I am really excited to talk about this today because so many people are confused on how leasing a car works. If you ask a dealer about leasing a car vs. buying a car they’ll just tell you that leasing makes it so you can get a better car for less money each month. Sounds great right? But oh how the opposite is true.
When I was a broke college student I was in the same boat. I almost ended up with a leased car my sophomore year in college. I am so glad that I never signed that lease agreement.
If you’re thinking about leasing a car, you really need to understand what you are getting yourself into.
A big problem with leasing is that people don’t understand how a car lease works. They usually equate it with renting which isn’t a very good analogy.
Why Dealers Love It When You Lease A Car
When buying a car the vast majority of people consider negotiating the price to be part of the process. However, in leasing a car the monthly payment is the focus rather than the total price – so people don’t usually think about trying to negotiate.
When you lease a car there is a number known as the capitalized cost. (You can think of it like the total price of the car when you are buying.) The capitalized cost is the agreed upon value that is used as the base cost for determining your monthly payment. The lower the capitalized cost, the lower the payment.
Now maybe you’re a smart consumer and you negotiate a good base capitalized cost. +1 point for you. But the battle isn’t over yet. The dealer has all kinds of tricks of his sleeve for round 2 – the financing.
To understanding financing, you need to understand how a monthly payment in a lease is calculated.
How To Calculate A Lease Payment
When you buy a car your monthly payment is based on the loan amount and the interest rate. In a lease, your car lease payments are based on the difference between the capitalized cost and the expected residual value. This difference is the depreciation of the vehicle.
Your monthly payment is equal to the (depreciation + money factor) / lease period.
The lease money factor is essentially the same as the interest you would pay on a loan.
If the money factor is the same as the interest rate, why don’t they just call it an interest rate? Well, in my opinion, the money factor is used to trick people into paying a higher interest rate. Most people don’t understand money factors so they don’t realize that the dealer may be offering an inflated rate on the lease.
Money Factor = Interest / 2400
Say you go to lease a car and you’re looking over the paperwork and the paperwork shows a money factor of .00375 (they may also show it as 3.75). I bet most people would think – “Oh .00375 sounds low. ”
The problem is, a money factor of .00375 is the same as an interest rate of 9%! .00375 doesn’t sound so good now does it?
Other Woes of Leasing A Car: Penalties
As if the dealer doesn’t fleece you enough when you lease a car, there can be all kinds of penalties tacked on at the end of your lease.
When you signed your lease agreement, (if you were paying attention) you probably noticed that there was something mentioning a mileage limit.
Since your lease payment was based on the car having a certain value at the end of the lease, the lease terms put a limit on the number of miles you can drive during the lease.
To account for decreased value for a high mileage car, the dealer will charge you a fee for each mile you drive over the limit. Usually this is in the ballpark of $0.35 per mile.
That means you will owe the dealer an extra $350 for going 1,000 miles over the limit. Take a cross country trip in your leased car? It may have cost you $1,000 in mileage fees.
Wear and Tear
Just like a car with high mileage is worth less – a car with excess wear and tear is worth less. That means the dealer has the right to charge you wear and tear fees to cover the additional depreciation.
When Is Leasing A Car Better Than Buying?
Now that I have beat leasing into the ground, is it ever a good idea to lease a car?
While I don’t think it ever makes financial sense I will at least point out the reasons to lease a car that most people have.
- Lower monthly payments let you buy a car that is above your means. Though you’ll pay more for it in the long run. And don’t even get me started on living above your means.
- Allows you to drive a new car every 3 years. This is good in that there is decreased maintenance expense. However, you will always have a car payment and will never be able to consider your automobile as an asset.
- You don’t have to worry about trying to sell your car down the road. But it also means that you won’t have a car at all at the end of your lease period.
- You will pay less tax as you are only taxed on the depreciation of the vehicle, not the entire purchase price of the car. Though, rarely does this outweigh all of the cons of leasing a car.
Car Lease FAQ
Who Owns The Car?
The leasing company owns the car. You cannot count a leased car as an asset. You have no equity in the vehicle whatsoever.
What happens at the end of the lease?
After you have paid all payments and fees, you simply walk away. Though, unless you have some alternate form of transportation you will likely purchase or lease a new vehicle when you turn your old one in.
You will also have the option to purchase the vehicle. You can either pay cash for the residual car value or obtain some type of financing.
This really is a sour deal though. At this point it is best to cut your losses and try to actually purchase a car you can afford.
Can you lease a vehicle with bad credit?
Yes. Just like you can buy a car with bad credit you can lease a vehicle with bad credit. And just like you’ll pay a higher interest rate when you get a loan with bad credit, you’ll pay a higher money factor when you lease with bad credit.
Can you lease a car with no down payment?
Yes. Sort of. You usually can find deals where you can lease with no down payment. However, the dealer will usually find some way to charge you a few hundred to $1,000 or more in fees before you drive off the lot.
If you are really determined to lease a car you should make the biggest down payment up front as you are able to. The bigger the down payment, the smaller the amount of the lease that is financed. Less financed means less interest paid.
Now that you know my stance on leasing, what’s yours? Think I’m way off base here? Tell me in the comments below!