Auto Leasing Basics
With almost one third of all new car deals made being leases, and with that number growing every day, it's easy to forget that leasing is relatively new in the world of consumer car shopping. In fact, even 10 years ago leasing cars was something that only governments, corporations and companies did. Ordinary people bought and owned their cars.
That's an important point to remember. When you lease a car, the company you lease it from owns it. You don't. Neither does the car dealer where you chose the car.
You pick the model, choose the color, select the sound system, and add on anything else that you want to have. Then the leasing agency actually buys the vehicle. In fact, they buy it for the amount of money you negotiate with the dealer for. As soon as the leasing agency buys the car, the dealership is out of the picture, except for delivery, warranties and maintenance.
While leasing is similar to renting, there are differences.
When you rent a car, you pay the rental company that owns it to use it. When you lease a car you are actually buying that portion of the car's value that you will use up during the life of the lease.
When you rent a car you are paying the daily, weekly or monthly rate the rental company charges, and that rate might have very little relationship to the value of the car or to how much the rental company has already made from renting that car. You can also turn the car in early, or, as a rule, extend the time you have it with little or no trouble.
One rental car may generate three or four times the income that an identical car does. When a rental car company puts one of its cars out for rent it has no guarantee of how much it will actually bring in.
But when you lease a car, the amount of money the car brings in to the leasing agent is spelled out in the contract. That's because when you lease a car you are agreeing to pay a predetermined amount over a fixed period of time, usually two years.
You are also agreeing to have insurance, get license plates and have it registered, pay any taxes that are due, and to be responsible for its upkeep and maintenance.
Even though you will be making a monthly payment when you lease a car, the payments will usually be smaller than they would have been had you decided to buy the car.
Here's why.
Let's look at a $20,000 car. We could also look at a $30,000 or even a $40,000 car, which is one of the reasons leasing has become so popular. Car prices keep going up beyond the monthly payment-making ability of many people.
So let's stick with a $20,000 car. Whether you buy it or lease it the car will depreciate, and it will depreciate at a predictable rate depending upon the model and options as well as the mileage and its general condition. For the sake of this discussion, we'll say that the car will depreciate $8,000 over two years.
(The number of miles you drive every year is one of the major determining factors when it comes time to decide between leasing or buying a car. We'll look at that part of it a little bit later on this web page.)
If you were to buy the vehicle and put $2,000 down you would have to finance the rest. So every month your payment will be used for two different things:
- Principal charge, which is paying for the car, $18,000;
- Finance charge, which is the interest on the $18,000 loan used for the principal.
Now let's look at the same car on a lease. The first difference is that you are not borrowing either $20,000 or $18,000. What you are borrowing is the price of the depreciation the car will suffer while you are leasing it. In this case, we're looking at $8,000.
To lease that $20,000 car for two years, which is the standard lease length, you will also be making monthly payments which can be divided into two parts:
- Depreciation charge, how much the car will depreciate in value, $8,000;
- Finance charge on the $8,000 you borrowed to pay for the depreciation, $8,000.
As you can see, you are borrowing a lot less money which means your monthly payment will be smaller -- often 30 to 50 per cent smaller. This is why you can often lease a more expensive car than you could afford to buy. More of your monthly payment goes toward the cost of the car instead of the cost of the money.
Another advantage is that leasing rarely requires a down payment, and even when a security deposit is required, it is rarely as large as the standard down payment. So all, or at least most, of that $2,000 you would have had to use as a down payment in buying a car can stay in your pocket when you lease.
Of course at the end of two years you no longer have a car. What you have is a decision. You can either buy the car and finance the remaining value, in this case $12,000, or you can hand the keys over to the leasing agency and walk away from it and into -- they hope -- another brand new car with a two year lease.
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