Disclaimer: TireBuyer does not provide financial advice. This material has been prepared for informational purposes only, and is not meant to be a replacement for professional financial advice. You should consult your own financial advisor before engaging in any transaction.
Folks are drawn to car leases for a wide variety of reasons. Some prefer the simplicity and limited commitment of a leasing arrangement, others like the idea of hopping into that new ride every few years. (Bling, bling.)
Despite its popularity, car leasing is widely misunderstood. Most lessees don’t get beyond the headline down payment and monthly payment figures. That’s good news for the car manufacturers, banks, and dealerships, but not ideal if you’re looking to maximize your financial position.
Thing is, just beyond the headlines is the full financial information that creates a great opportunity for savings. In fact, car leasing provides more financial definition for your car “ownership” situation than a traditional purchase arrangement, but only if you pursue the full info before signing on the dotted line.
Here are some principles and concepts to keep in mind as you embark on any car lease.
Flip your mindset from “renting” to “owning.”
It sure is tempting to think about a car lease as very similar to a rental, and without a doubt that’s the way that car leases are promoted – “Lease a car for $349 per month with just $1,400 down.” But unlike that economy rental you copped from the airport, your leased vehicle is going to be sticking around for the long-term. And if you want to return a leased vehicle a bit early, it’s a lot more complicated than returning a rental to the airport car park.
So before anything else, understand that you’ll be buying and owning the leased vehicle for the term. Like anything else you’re going to buy/own, financial due diligence is advisable.
Understand the economic basics of car leasing.
So how do you go about that financial due diligence? Alright, this is as math-y (new word) as this is going to get, but all of these details are mandatory.
As suggested above, car leasing provides complete financial definition of your vehicle ownership. Especially when contrasted with a traditional purchase arrangement where your vehicle depreciation is mostly an unknown.
Which brings us to one of the primary financial considerations of a car lease: Depreciation.
What is it? Depreciation is the amount of value a vehicle loses over time, as a vehicle is used and mileage is accumulated.
Buy a vehicle traditionally and your depreciation at any given ownership stage is the difference between what you paid, and what someone privately (or a dealership) will pay you for your ride, which is an unknown.
Lease a vehicle, however, and you know exactly what your vehicle is worth at the conclusion of your ownership (lease) term. Cool, huh?
Known vehicle depreciation during a lease is due to a lease factor called residual value. Residual value is what your vehicle’s value is going to be at the conclusion of the lease term. This is projected at lease inception and doesn’t change. (Assuming normal use, wear and tear, and sticking to the allotted mileage.)
So a hypothetical lease deal goes like this:
Vehicle MSRP is $48,679, and your negotiated purchase price (aka Adjusted Capitalized Cost) on the lease is $43,000. (More on this below.)
Residual value, which is set as a percentage of MSRP, is non-negotiable and set by the car manufacturer. Let’s say the residual value is 59%, then the depreciated vehicle value/residual value is $25,370. This is the predefined value of your vehicle at the end of a lease term (e.g., 36 months).
The difference between your purchase price and the vehicle’s residual value at the end of the lease, divided by the term (36 months), is the base monthly payment.
$43,000 – $25,370 ÷ 36 = $489.72
Next up is the money factor, which is a fancy term for good, old-fashioned interest.
Along with your purchase price, and probably even more so, this is where the rubber meets the road for car dealerships. This is where they can make financial hay.
The thing to keep in mind on money factor is that you want the best available. Note that the best available for you is not necessarily the best available money factor arrangement for them, and so it’s safe to expect that initially you might be delivered a money factor (interest rate) that’s higher than the best available.
Sometimes the best available money factor on a lease is through the vehicle manufacturer’s finance wing. Other times it’s going to be through a third-party bank who wants in on the action.
Again, the thing to keep in mind is that you want the best available. Once that rate has been disclosed to you, then you can do the very basic math on the monthly interest payment and determine if it’s agreeable and worth it to you to go ahead and lease the vehicle.
Money factor is converted to a dollar figure by adding the purchase price/Adjusted Cap Cost and residual value figures, then multiplying by the money factor rate like this:
Money factor = 0.00105%
$43,000 (Adjusted Cap Cost) + $25,370 (Residual Value) x 0.00105 = $71.79
$489.72 (Base payment) + $71.79 (Money Factor) = $561.51
Then the only remaining economic variable is Uncle Sam’s take, which is your state tax. At 6% state tax, for example, that would add another $34.05 per month ($567.47 x 1.06), for a total lease payment of $595.20.
You can negotiate the purchase price of a lease.
The purchase price of a leased vehicle, which in car lease parlance is called the Adjusted Capitalized Cost, is negotiable just the same as it is in a traditional purchase arrangement. As outlined above, your negotiated purchase price has a direct effect on your monthly payment.
Using the example above, if we negotiate a bit harder, and purchase the vehicle for $41,500 instead of $43,000, that would save $41.67 per month.
You want to be provided with the financial information in the final car lease worksheet, all of it.
In basic terms that any dealership salesperson will understand – but won’t necessarily want to acknowledge – you want full economic details of your intended lease arrangement. Preferably, laid out in straightforward terms absent any extraneous info. You need all of the details outlined just above to understand your position fully.
The request could go something like this: “Please provide me with all of the financial details that will be provided to me when the lease is executed. The full lease worksheet. I’d like to see those details in advance.”
If that’s met with an “I can’t disclose that,” or “I don’t have access to those details,” then you might be working with the wrong dealership.
You don’t care about your monthly payment.
Well, or at least that’s not your posture with your friendly dealership salesperson. Dealerships thrive on the idea that you have a monthly payment in mind. Whether leasing a car or purchasing, they have methods to make that monthly payment a reality, but over the long-term (or even with near immediacy) your ownership position will very likely be weak.
Instead of the monthly payment leading the way, the math as outlined above is the benchmark. Your lease payment should be based on the hard math of the situation.
And in many cases, those mathematics will work out in your favor – that is, less than the maximum monthly payment that you had in mind, but didn’t disclose that because you’re a boss.
There are better times to lease a given vehicle.
Residual values (% of MSRP) and interest rates fluctuate, sometimes significantly. Additionally, incentives and rebates from the manufacturers are sometimes in play. And so there are opportune times to lease a particular vehicle, and other times where it will be impossible to match the lease “deal” of last year.
If you’re vacillating between leasing two or more vehicles, then the superior lease details and incentives could be the deciding factor.
Shopping around can be a good thing.
Once you’ve established yourself as not a typical dealership mark, well, some will react to that more favorably than others. It may be necessary to look elsewhere if Dealership A isn’t willing to deal. Because Dealership A might thrive on the leasing = renting crowd and doesn’t want to be bothered with a negotiation. If that’s the case, so be it. Move on.
You don’t have to put money down on a lease.
Would you rather roll that down payment into your monthly payment and keep your hard-earned capital in hand? Don’t blame you. Ask your dealership salesperson to figure the lease from the get-go with $0 down payment in mind. Leases don’t require money down, but anytime someone can be convinced to hand over thousands of dollars, well, that’s good business.
Negotiate your lease properly, and you can exit penalty-free, or even with money out the deal.
Crazy right? It’s true though – negotiate your lease favorably, and you won’t necessarily be stuck in an “underwater” lease arrangement until your lease term expires.
Let’s say you didn’t fall in love with the vehicle, or something else has caught your eye. At any given point in the lease, your position is defined by the headway you’ve made on your depreciation. To calculate your “buyout” at any stage in the lease, take your residual value and add the sum total of remaining payments.
If you’ve paid more into your vehicle than it’s depreciated, or put another way, your vehicle’s value is greater than the residual value + sum total of remaining payments, then you’re ahead of the curve. Trade in that sucker penalty-free with a cooperative dealership, or better yet, advise your salesperson that you’re confident in your lease equity and expect that to be rolled into your next lease.
“Lease equity” is a real thing.
Don’t be convinced otherwise. Some dealership salespeople might look at you like you’re a talking Bigfoot, but lease equity is a real thing and something that you can leverage in your favor. If you paid into the vehicle more than it’s lost in value, then you’re due that consideration.
All of this isn’t to say that you shouldn’t approach any lease arrangement negotiable, and with reasonable expectations. The dealership, the banks, the car manufacturer, everyone involved with facilitating the lease deal needs to make a chunk of change to keep doing what they’re doing.
But follow these principles, and you can be sure you’re not the one contributing just a bit too much.