Leasing A New Car?
Here's Everything You Need To Know
©2013 Fighting Chance® & James Bragg
Thinking of leasing a new car and pondering these questions? Should I lease or buy, which is best for me? How does leasing work? What am I paying for when I lease? What elements can and can’t I negotiate? How do they calculate my monthly payment? How are leases taxed? Will I get the incentive if I lease? What’s in a typical leasing “drive-off’ check?
If you’ve answered “yes” to any of these questions, this "Leasing 101" guide has the answers you need. At no charge.
Over the years, I’ve talked to thousands of smart folks who didn’t understand leasing. Many were in previous leases, but had no idea whether their deals had been good or bad. Most couldn’t explain what they were paying for or how their payments were calculated. They only knew that their monthly payments were lower than they’d be if they were buying.
I’ve also talked to many others who were on the fence between buying and leasing, undecided about which alternative would be best for them.
Finding no straightforward, clear and thorough consumer guide to new car leasing on the Internet, I decided to write one and put it here to help my website visitors. (It’s exactly the kind of information I needed to understand leasing when I started this business over 20 years ago.)
Some of you may choose to become Fighting Chance customers and have us help you negotiate your next new car lease like an expert.
Our information package has all the instructions our customers need to negotiate the best lease, telling them exactly how to get dealers' to compete for their business.. And when they’ve got all the key lease numbers from their best offer, but before they’ve signed anything, they can call us. We'll check their vehicle’s residual value against the number in the current Automotive Lease Guide’s Residual Percentage Guide, then take a calculator and run the lease numbers with them to be sure the monthly payment they’ve been quoted looks right.
I’d love to have you as a customer, but I’m glad to demystify leasing here for everyone who wants to break the leasing code dealers don’t want us to know.
WHAT'S AUTO LEASING?
Think of it as long-term car rental.
You, the lessee, agree to make specified monthly payments in return for driving car a maximum number of miles over an agreed-upon time period — typically two to four years.
The entity that leases you the car is the lessor — a financial company that buys the car from a dealership and leases it to you. Most often, the lessor is the automaker’s captive finance company, but it could also be a bank or other independent financial institution. The transaction is arranged by the dealership, acting as a middleman between you and the lessor.
At lease-end, you return the car to the lessor through a dealership for that brand, and you’re back to Square One. It’s not a “trade-in” because it’s not your car, it’s theirs. You’ve just paid to drive it around for a few years.
HOW SIGNIFICANT IS AUTO LEASING?
About 15% to 20% of new-vehicles are leased today. In the 1990s it was 20% to 25%, but the recession and the significant rise in the price of gasoline has depressed leasing’s penetration.
WHICH SOURCES OFFER THE BEST LEASES?
The most attractive, cost-effective new-vehicle leases almost always come from the automakers’ captive finance companies (Honda Financial Services, Toyota Financial Services, Ford Motor Credit, etc.). That’s because the auto companies can subsidize their captives’ leases by taking some of the profit they make selling cars to dealers and using that money to inflate residual values and/or cut interest rates to reduce monthly lease payments. They don’t send that subsidy money to banks, credit unions or other financing entities, so it’s difficult for third-party leasing providers to compete on monthly payments with the automakers’ lease terms.
All dealers have access to other leasing sources. Those alternative sources can be helpful to dealers because many of them will lease to customers with credit scores below those required by the automakers’ captive finance companies.
You’ll find lots of “auto leasing companies” in the Yellow pages and on the Internet. Avoid them. They are just another mouth to feed — “middlemen” between you and the dealer. They must buy your vehicle from a franchised dealer, and they don’t have access to the subsidized leases offered by the automakers’ captive finance companies. Negotiate the best deal you can on your own. Then, if you wish to involve them, tell them the details and ask if they can beat it. They seldom will.
SHOULD YOU BUY OR LEASE?
The monthly payments will always be lower for leasing than for buying over the same time period. But leasing can be a great choice, a so-so choice or a terrible choice, depending on your situation and how you feel about spending your money.
Leasing makes the most sense for people who give a strong positive answer to one or more of these questions:
By contrast, buying makes the most sense to people who answer one of more of these questions positively:
Leasing is a good option for those who trade often and drive a moderate number of miles each year, especially if they can write off payments as a business expense. Leasing is a smart choice for anyone who gets a new car every three years because they’ll know all the costs up front and never have to worry about the value of their trade-in.
But leasing will never be the most cost-effective way to get around. If you lease forever, you’ll make car payments forever. The way to get the most value for every new-vehicle dollar you spend is to buy a reliable car, pay it off in a few years, then drive it several more years when you’re not making car payments.
WHAT ARE YOU PAYING FOR WHEN YOU LEASE?
Leasing seems more complicated than buying. Much of the confusion comes from leasing’s weird terminology, but the concept is simple and relatively easy to understand. To illustrate, let’s examine the basic elements to see what we’re paying for.
We’ll make the following assumptions for a 36-month lease:
1. The car you want has a retail/sticker price of $24,000.
2. You can negotiate a $22,000 transaction price. (In leasing lingo, that’s called “the agreed-upon price of the car.” It’s the price at which the dealer sells the car to the leasing company, and is the major piece of what they call “the capitalized cost.”)
3. The car is estimated to be worth $12,000 at the end of a 3-year lease. (That’s called “the residual value” or “lease-end value.”) It will typically be the lease-end "buy-out price" listed in your lease document.
The first (and largest) part of your monthly lease payment will cover the depreciation. In this example, that’s the difference between the $22,000 agreed-upon price of the car and its $12,000 lease-end value, or $10,000. You are borrowing that $10,000 and paying it off over 3 years. In effect, it's just like you've purchased a $10,000 used car with no money down and are paying it off, principle and interest, over 36 months.
The second (and next largest part of your payment) is what you and I call “interest” and leasing companies often call “rent” or a “lease fee.” It’s the equivalent of interest charges on an auto loan. You are paying interest on two lease elements:
So in total, you are paying interest on (a) the depreciation balance of $10,000, which declines each year as you pay down the principal, and on (b) the residual value of $12,000, which remains steady over the lease term.
The third part of your monthly payment is the sales tax. In most states, the tax will be a percentage of your pre-tax monthly payment. (If your payment is $300 and the sales tax rate where you live is 7%, the tax will be $21 per month.) But in Illinois (and perhaps other states), you will pay the sales tax on the full negotiated price of the car, just as if you were buying — a significant disincentive for leasing there. (A few states, like New Hampshire and Oregon, have no sales tax.)
In most states you’ll pay the sales tax each month as part of your payment. But some states (e.g., New York and New Jersey) want all the tax money up-front for the entire lease term, which means you’ll either write a check for that total or add it to the agreed-upon price of the car to increase the capitalized cost of the lease, in effect borrowing that money and paying it off with interest over the lease term.
Check the law in your state to understand how leases are taxed there. No dealer would try to cheat you by adding more tax dollars to your lease than you’ll owe. They’d get caught doing that, and your state’s Attorney General would be on them like ugly on a baboon.
There are some additional one-time costs attached to leasing.
These fees are the main ways the leasing companies make money. Financial entities have more expenses on leases than on purchases. If you don’t buy the car at the end of the lease term, they must pay someone to inspect it for excess wear and tear, fix whatever needs fixing, then ship it to an auction open to dealers who sell that nameplate. (Those dealers get “first dibs” on off-lease cars, most of which end up on the used-car side of their business as “factory-certified” used vehicles.) The acquisition and disposition fees help the leasing companies cover those costs.
Worth noting: Many of those leasing ads that feature low monthly payments are based on a mileage limit of 10,000 miles per year. (Check the fine print.) If they were figured on 15,000 miles, the payments would be higher.
WHAT CAN YOU AND CAN’T YOU NEGOTIATE IN A LEASE?
Your pre-tax monthly payment is determined by three key elements: (1) The agreed-upon price of the car, the core of the capitalized cost; (2) the residual value; and (3) the interest rate, which leasing companies call the “the money factor.”
The only one you, the lessee, get to negotiate is (1), the price at which the dealer sells the car to the leasing company.
The leasing company (NOT the dealer) determines the residual value, so it can calculate how much to charge for depreciation. The reference “bible” leasing companies use to establish this value is the Automotive Lease Guide’s “Residual Percentage Guide,” which is published every two months, listing projected wholesale values of vehicles after 2, 3, 4 and 5 years. Residuals are stated there as a percentage of a vehicle’s original retail/sticker price (MSRP). They are realistic estimates of the price leasing entities will realize when they auction the leased vehicle to dealers selling that nameplate. (We subscribe to that Automotive Lease Guide publication. Our customers can call us to check the number they’ve been given.)
While the ALG’s residual numbers are realistic estimates, different leasing companies can place different residual values on the same vehicle. But all dealers quoting on leases from an automaker’s captive finance company should be using the same residual value.
The leasing company also determines the interest rate, or “money factor.” Lessees with the highest credit scores typically get the best rates, just as they do when they are buying. If the rate is at or near the going retail market interest rate for car loans, chances are the dealer will earn some profit on it. But if it’s a factory-subsidized lease through an automaker’s captive finance company with a money factor/interest rate well below the market rate, there’s usually no money in that for the dealer. in that instance, the automaker is charging you a lower rate then it’s paying for the money, using some of the profit it made selling the car to the dealer to cover that cost.
HOW DO THEY CALCULATE YOUR MONTHLY PAYMENT?
It’s 5th grade arithmetic. You don’t need leasing software. Any cheap calculator will be sufficient, including the free one on your computer.
Let’s assume you want a three-year lease, 15,000 miles a year.
To calculate the lease payment, you need the following information, most of which you will get from the dealer:
Now let’s calculate the payment using the base assumptions we made in the example in the section above titled “What Are You Paying For When You Lease?”
To figure the monthly depreciation charge, subtract the $12,000 residual value from the $22,000 capitalized cost, leaving $10,000 in depreciation. Divide $10,000 by 36 months, and you'll get $277.78 per month.
To figure the monthly finance charge, add the $22,000 capitalized cost to the $12,000 residual value, for a total of $34,000. Multiply that $36,000 by .0025 (the money factor for 6% interest) to get a monthly finance charge of $85.00.
DO YOU GET THE INCENTIVE IF YOU LEASE?
Yes, but often in a different place.
Most automakers’ incentives today are stated as rebates or “customer cash,” with low-interest financing as a typical alternative. The consumer chooses between them. These programs apply to buying, not leasing.
Car companies will typically allocate the same incentive money to subsidize leases, lowering the monthly payments. They give that money to their captive finance company, which applies it to one or more elements of the lease.
Let’s assume there’s a $1,000 incentive. In a lease, you may see it in one of three places, or in a combination thereof. It may be used to:
• Reduce the capitalized cost.
• And/or increase the residual value.
• And/or reduce (“subvent”, or buy down) the money factor/interest rate.
When you analyze the lease numbers, you will see the impact of that $1,000 in one or more of those places.
WHAT’S IN A TYPICAL “DRIVE-OFF” CHECK?
Don’t call this “a down payment.” It’s not. It’s just the check you write that enables you to drive the car home.
The drive-off check most Fighting Chance customers write includes three elements: the first monthly payment, the Motor Vehicle Department’s registration fee and the lease acquisition fee. If you don’t include the acquisition fee, it will be added to the agreed-upon price of the vehicle and increase the final or "net" capitalized cost.
In states requiring all the sales tax money up front, some customers add that amount to the drive-off check, while others roll it into the capitalized cost and pay it over the lease term.
Anything you pay up front over and above these items, either in cash or in the value of a trade-in, is what you and I would call a “down payment” and leasing companies call a “capitalized cost reduction.” That additional money would pre-pay some depreciation, reducing your monthly payments. (On a 3-year lease, each extra $1,000 you pay up front would reduce your basic pre-tax monthly payment by $27.78 + interest.) Note: Cap cost reductions are taxed at the same rate as monthly payments.
Note that in many automakers' leasing ads featuring attractive low monthly payments, the “fine print” often lists a hefty required initial payment of $2,000 to $3,000 or more, much or most of which is a capitalized cost reduction. (Incidentally, you can often beat the monthly payment featured in those ads by negotiating a lower “agreed upon” price than the one assumed for the ad. That’s because automakers can’t assume a price so low that it will anger their dealers. Sometimes those ads are based on the full retail/sticker price.)
CAN YOU DEAL ON THE VEHICLE AT LEASE-END?
Many lessees purchase their vehicles when their leases end. They know the car and how it’s been treated and decide to keep it.
The residual value stated in their lease contract is the theoretical buy-out price. Some lessors may refuse to negotiate a lower price. Others may be more flexible.
In a factory-subsidized lease, the residual may have been inflated substantially, resulting in dramatically lower payments. If so, you’ve had the benefit of these lower payments for several years.
The result, however, can be a buy-out price at lease-end that’s dramatically higher than the vehicle’s market value. The lessor may say it was “pay me now or pay me later,” but the fact is they will net dramatically less than that residual value when they auction the car to dealers. So they may be open to negotiating a more reasonable price.
My advice: check the asking prices for similar vehicles on websites like cars.com and autotrader.com and figure you can buy them for about 10 percent less. Then make an offer for your car. If the lessor wants substantially more than your car’s market value, find another vehicle to replace it.
THAT'S LEASING 101. (The basics, demystified.)
Last word to the now-wiser: Only someone who just fell off the turnip truck would walk into a car store and ask, “How much a month to lease that car?” With a lease, you negotiate the price of the car first, just as you would if you were buying the vehicle. That's where your leverage is on the monthly payment. (Some websites tell you to pretend you're buying, negotiate the car's price, then tell 'em you're leasing. There's never been a good reason to do that. Instead, you'll state up front that you're leasing, but that you'll start by negotiating the price, not by talking about monthly payments. It's the same sale to the dealership, whether it's to you or to the lessing company.
The Fighting Chance information package contains everything our customers need to negotiate the best “agreed-upon price” for their leased car through a competitive bidding process, without walking into a car store. There are several pages of instructions on what to do and when to do it, what to say to dealers and when to say it, each step of the way. Including a sample message they’d send dealers requesting price proposals and leasing number details.
And once they have all the key numbers on the best lease they’ve been offered, they can call us. We’ll check their vehicle’s residual value in the Automotive Lease Guide and run the numbers with them to be sure the monthly payment they’ve been quoted looks right.
If you like what you’ve read, why not have the folks who wrote it help you navigate through your next lease negotiation like a pro?
You may place an order here on a secure, encrypted order form at any time.
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