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Leasing a Car: When Is Leasing a Good Idea?

More than a third of all new cars are leased each year. While the lower monthly payments are eye-catching, knowing the ins and outs of leasing is critical to understanding if it’s a good deal.

So here’s a handy guide to what car leasing is all about. We’ll cover how leases work, whether or not leasing fits your lifestyle, and how leasing can figure into your budget. We’ll also take a look at the downside of leasing and what to avoid if you decide this alternative to a car purchase is for you.

Car leasing basics

Instead of outright ownership, car leasing is more of a long-term rental over a set time that could be as short as a year or extend out as long as four or five years. The monthly payment is determined by several factors, the largest of which is the vehicle’s depreciation, or the amount of value it has lost while you’ve driven it. That depreciation is also related to the number of miles you put on the vehicle and its condition at lease end. This figure also includes the cost of financing the transaction.

While all these costs and depreciation may sound overwhelming, in the end, your monthly payment is lower because you are only paying for the use of the vehicle, and not the full purchase price. Special lease deals are also a way for an automaker to put incentives on a vehicle without affecting the advertised Manufacturer’s Suggest Retail Price (MSRP).

Lower monthly payments are attention-grabbing, but keep in mind that while buying a car only appears to cost more because of the higher monthlies. But at the end of your payments, you own the vehicle and therefore can recoup some of those higher costs through the resale or trade-in value. At the end of the lease, your lower monthly payments will have netted you the transportation provided by your car and nothing else.

When you should lease rather than buy

Leasing a car can make more sense than an outright purchase under a certain set of circumstances. The biggest factor is your annual mileage. If you put less than 15,000 miles per year on your car, then leasing might be a good option. Mileage is the most important element in determining your car’s resale value. A car driven only 10,000 to 12,000 miles per year will be worth a lot more than a car that sees 15,000 to 20,000 miles on its odometer annually. Your payment will be calculated on the projected resale value—the higher the value, the lower the payment.

Others may opt for leasing because they like having a late model car and have budgeted a fixed amount for transportation expenses. The advantage here is in addition to trading into a new car every two or three years, you may also find this lower monthly lease payment may allow you to drive a more expensive and feature-laden model for the amount you’d pay for the purchase of a lesser model.

Advantages to car leasing

Prices of new vehicles continue to climb each year as manufacturers add new features and technology. Leasing allows you to keep your car payment in check. Also, as mentioned earlier, leasing is a good way for makers to package incentives and rebates into an attractive monthly payment. These incentives may be more generous than the discounts or low-interest rate offers given to traditional cash buyers.

High prices also present another challenge to traditional vehicle purchases. To keep payments down, buyers are faced with taking longer-term loans that can extend beyond five, six, or even seven years. That’s a long time between getting into a new car, especially as the pace of model changes and the addition of new technology has quickened. If you want to drive a new car, leasing is the way to go since most range from two to four years in duration.

Leasing also has the advantage of not having to worry about what to do you’re your old car when you’re ready to get a new one. Since you have no stake in that vehicle, trade-in values or trying to sell it to a private party are non-issues. Also, the shorter lease term also means your vehicle will likely be covered by the manufacturer’s warranty the entire time you’re in it. Not so with a buyer who may still be paying down their loan long after the warranty has expired.

Disadvantages to car leasing

Keep in mind there are drawbacks to leasing. If you drive a lot of miles, you may find it more cost-effective to buy the car and keep it. Most leases cap mileage anywhere from 10,000 to 15,000 miles per year. Put more miles on the vehicle and you open the door to excess mileage cars, some of which can range as high as 25 cents per mile. You could face the prospect of paying thousands when it comes time to turn in the vehicle.

In addition to mileage, the lessee must cover any damage or excess wear and tear on the car. Scratches and dings are considered normal wear and tear, but make sure to read the fine print to determine what excess wear and tear looks like and for what and how much you are liable.

Remember that a lease is a contract and you’re committing to making the payments for the duration. If you decide you want out, you may be liable for the balance of your payments. Be sure to carefully check the lease to determine your liability.

How to tell if a car lease is a good deal

Low monthly payments look good on paper, but you also have to consider all the money you’re required to bring to the deal. That includes upfront or down payments required to close the deal. A $1,200 advance payment is like adding $50 to your monthly on a 2-year lease. Also, be aware of additional charges like acquisition and disposal fees than can add up to $1,000 to your total cost. You can also make these additional fees a point of negotiation in the final deal.

All these payments, including any taxes, license, and registration fees, should be divided by the term and added to your monthly payment to determine your true out-of-pocket costs.

So what should you expect to pay? Auto industry finance expert Experian pegs the average monthly car payment at about $550 and estimates that the average lease runs about $100 less. For a good deal, expect to pay from $100 to $150 at most per $10,000 of a new vehicle’s price. Since a new vehicle costs $35,000 on average, your lease payment should fall somewhere between $350 and $525 per month.

Other payment considerations

Three basic factors make up a lease:: how much it costs to acquire the vehicle, the interest charged to cover the financing and what the vehicle will be worth at the end of the lease.

The biggest component is what’s known as the capitalized cost. That’s the amount that the lessor pays for the vehicle. It can be below invoice if it’s a slow-selling model or closer to MSRP if the vehicle is in high demand. That amount has a direct impact on what you’ll pay monthly.

Usually, the vehicle is acquired with borrowed money, so finance charges will be based on lessor’s cost of money. Since leases are held by large financial institutions or the manufacturer’s credit arm, usually they have access to money at rates far lower than you’d pay if you purchased the car with a conventional loan. This also helps to reduce the monthly payment.

Any additional money in the form of down payments or manufacturer incentives also reduces the capitalized cost of the vehicle. Another important factor is the value residual or resale value of the vehicle assigned to the deal. A high residual lowers capitalized cost and lowers the payments; a low residual raises that cost and the monthlies. Before signing the deal, be sure to go over all these figures, especially the residual value to see if it aligns with the current resale value of a comparable model.

Who is responsible for a leased car?

Since a lease is like a long term rental, you, as the lessee, is not the owner of the car. More often than not, the real owner is the financial institution backing the lease. It can be a manufacturer’s credit arm or a bank. Even though you don’t hold title to the vehicle, you are responsible for its use, which includes registration and insurance.

This is a key point. If you have an accident or theft and the vehicle is a total loss, you’re responsible for replacing it. If the replacement cost exceeds the book value of the car, you have to cover the difference. That’s why extra-cost GAP (Guaranteed Asset Protection) insurance coverage is often recommended in a lease.

What to expect at lease end

Traditional leases come in open and closed-end contracts. The latter is also known as a walk-away lease where you have no responsibility outside excess mileage or wear and tear costs. The lessor in this case is responsible for the vehicle’s disposal. If the vehicle is worth more than market value, the financial institution profits. If not, it has to eat the cost. Typically, because of this higher risk, a closed-end lease will cost more than an open-end contract.

Lessees in open-end leases share the risk. If the vehicle is worth more, you may see some money back. If it’s not, you may be liable for the difference. Beware here of so-called balloon payments where the resale value is set artificially high to keep monthly payments down. At the end of the contract, the lessee is required to come up with this payment.

Open-end leases also have a purchase option. You should know this number up front when you sign the deal. This option to buy can pay dividends if used car values are up and you can buy the car you’ve been driving at a below-market price.

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