Do-It-Yourself Guide To Leasing

You've seen the ads: a Honda Civic for $189 a month. A Jeep Grand Cherokee for $289 a month. A GMC Yukon for $389 a month. Wow! You can't believe your eyes. Visions of shiny new golf clubs in your trunk, a big-screen TV in your living room and two weeks of prime vacationing in Vail release endorphins at twice the surgeon general's recommended level in anticipation of big savings.

But be careful, because you probably shouldn't believe your eyes when you read such banner ads, not until they're grazing over the fine print. See where it says "Capitalized Cost Reduction"? That's lease-speak for down payment. See where it says "30,000 miles over three-year term"? That's lease-speak for "You're going to the Safeway and back -- and that's all, folks." Want the car for zero down? That's going to cost you. You drive someplace more than twice a month? That's going to cost you, too.

Like most consumers, you want to know how to buy or lease the car of your choice for the best possible price. Buyers are attracted to leasing by low payments and the prospect of driving a new car every two or three years. Many people figure that a car payment is an unavoidable fact of budgetary life, and they might as well drive "new" rather than "old." True, leasing is an attractive alternative, but there are some things that you need to understand about leasing before jumping in feet first without a paddle. Whatever. You know what we mean.

How to Lease

Never walk into a dealership and announce that you want to lease a car. Don't talk payment, either. Once a salesperson identifies you as a payment shopper, you're a dead duck. Any competent dealer can find a way to make a car fit your budget while maximizing profit simultaneously. Concentrate on finding a car that you like, and know before you go into the dealership what you can afford in terms of sticker price.

Lease payments are based on the capitalized cost, which is the selling price of the car. The residual value is the predicted value of the vehicle at the end of the lease term, and can be expressed as a percentage of the MSRP. Sometimes the residual value is not the predicted value of the car at the end of the lease, but a number that allows the leasing company to lower the cost of the lease as much as possible without incurring excessive risk when it comes time to sell the off-lease vehicle. A money factor, which is lease-speak for "interest rate," is also involved in the calculation of a lease payment. If the money factor is expressed as a percentage, convert the percentage to the money factor by dividing the number by 24 (yes, it's 24 regardless of the term of the lease). For example, a seven percent (.07) interest rate converts to a .0029 money factor. Then, of course, there are associated taxes and fees that are added. Accept the fact that if the car you want to lease is not a popular model, your lease may be a bit higher than you anticipated.

Calculating an actual lease payment beforehand is nearly impossible, particularly when the lease is subsidized by the automaker, but you can arrive at a ballpark figure by using the following formula, which we will illustrate using a 2000 Honda Accord EX V6 as an example. Remember that if you put any money down, or trade in your old car, you must deduct this amount from the capitalized cost. This deduction is called the capitalized cost reduction. We recommend paying the destination charge, the acquisition fee, the security deposit and any taxes up front rather than rolling them into the lease.

2000 Honda Accord EX V6

* Most leases also require that the first monthly payment be made at lease signing.

For comparison purposes, we used Honda's web site lease calculator (http://www.honda2000.com/models/calculators/index.html) to see what American Honda Finance Corp. (AHFC) would quote us using as many of the same parameters as possible from our example above. The Web site calculator told us on October 6, 1999, that this sample Accord EX V6 would run $339.80 per month, for a 36-month lease with 15,000 miles allowed per year and $1,350 down on a cap cost of $22,490. AHFC reported a residual value at the end of the lease of $14,479.70, which is $486.20 higher than our estimate, and a disclaimer indicated the AHFC quote was based on a net capital cost of $21,590, which is $900 lower than our example. This lower cap cost, according to the disclaimer, is dependent on dealer participation, which tells us Honda is subsidizing Accord leases to the tune of $900 in dealer cash and that it's the dealer's prerogative whether or not the consumer shares in that factory money. The bottom line is that a 2000 Accord EX V6 should run between $340 per month and $375 per month with little money down. If this fits your budget, so does the Accord EX V6.

Keep in mind that every vehicle will have a unique residual value, based on its popularity, its resale value and its reputation for reliability and dependent of the term of the lease. Also remember that the above formula doesn't take the following into account: delivery and handling (D&H fees), documentation fees, the cost of license plates, city or county sales tax (if applicable in your part of the country), or trade-in values. The trade-in value and any cash down payment should be deducted from the capitalized cost before calculating the lease.

If you're upside down on your trade, which means the car is worth less than you owe on the loan, you'll need to add the difference between the balance due on the loan and the trade-in value to the capitalized cost.

The example we illustrated is a straightforward lease with no factory subsidy. This formula will not account for subsidized leases, as evidenced by the subsidized payment the Honda web site calculated. Subsidized leases allow dealers to lower payments by artificially raising residual values or lowering the capitalized cost through dealer incentives. You can easily recognize a subsidized lease. Any nationally or regionally advertised lease is generally subsidized by the manufacturer to keep lease payments low. The $289 per month Jeep Grand Cherokee popular in TV and newspaper advertising is an example of a subsidized lease payment.

Actual lease payments are affected by negotiation of the sticker price on the vehicle, term of the lease, available incentives, residual values, and layers of financial wizardry that even sales managers can't interpret without divine intervention. Once you find a car you can afford, negotiate the sticker price and then explore leasing based on the negotiated price. Ask what the residual value is and subtract any rebates or incentives from the capitalized cost, and remember that you'll need to pay tax to Uncle Sam for that discount. Use the formula above to calculate a ballpark figure, and if the dealer balks at your conclusion, ask them to explain the error of your ways.

Your best bet when leasing is to choose a model with a subsidized lease. Payments are low, terms are simple to understand, and they are the only true bargain in the world of leasing.

Low payments aren't a fallacy with leasing, when taken in proper context. Let's look at our Honda Accord EX V6 example again. To lease for three years with a minimal capitalized cost reduction (down payment) of $1,350, it'll cost you about $350 per month (plus tax and fees). To buy that Accord, financed for 36 months at a nine percent annual percentage rate (APR) with $1,350 down, you would pay about $685 per month (plus tax and fees). So you see, leasing is cheaper in terms of a monthly payment when compared to financing for the same term.

There are two flaws here. First, 60-month financing is now the standard, and 72-month financing is becoming more popular. Using the same APR and down payment, the Accord will cost right around $445 per month (plus tax and fees) for five years and still be worth a good chunk of change at the end of the loan if cared for properly. Second, ownership is far less restrictive, even if the bank holds the title until 2005. You can drive as far as you want, paint the thing glow-in-the-dark orange with magenta stripes, and spill coffee on the seats without sweating a big wear-and-tear bill down the road. Leasing for three years costs about $13,500 (assuming you get the entire security deposit back), and you don't own the car at lease-end. Financing for three years costs about $26,000, but you own a car worth about $14,000 when the payment book is empty (unless, of course, you've actually painted it orange with magenta stripes and spilled coffee all over the interior), which makes your actual cost close to $12,000. Is leasing cheaper? Monthly payments, when compared to financing over the same term, are lower. But in most cases, leasing is actually more expensive.

Let's compare the longer-term effects of leasing vs. buying, over the same term and under identical conditions. By leasing the Accord in this example for three years, and then buying the car for its $13,993.50 residual value with two-year financing at a higher interest rate than you would have paid new (interest rates rise as the vehicle gets older), you pay thousands more for the car. Assume the interest rate for 24 months on a three-year-old Accord is 11 percent. Payments for the loan would total about $650 per month, or right around $15,600 for the life of the loan. Added to the cost of the three-year lease, the $23,000 Accord has cost you $29,100 (plus tax) with average payments over 60 months of $500 per month (plus tax). Had you bought the Accord outright, financing for 60 months at nine percent interest, the Accord would have cost $26,700 (plus tax) with monthly outlays of $445 (plus tax).

But there are several factors that should be kept in mind. When leasing, tax is calculated on the payment; when buying, tax is calculated on the selling price. At a 6.5 percent sales tax rate, the Accord costs the buyer using conventional 60-month financing roughly $300 less in sales tax than the buyer who leases and then purchases the car at the residual value. Other factors, like fluctuating interest rates, down payments, and contractual obligations can also affect the lease vs. loan scenario. Additionally, vehicle condition can have a tremendous affect on value. A few dents, dings or scratches could easily make a lease the more expensive proposition, with charges for worn tires, excessive mileage and cosmetic repair likely to top $1,000 at the end of the contract.

When trying to determine if leasing or buying is right for you, carefully weigh all the factors that can affect payments over the term of the lease or loan, including the way you drive and maintain a vehicle.


Restrictions

Leasing severely restricts your use of a vehicle. Mileage allowances are limited, modifications to the vehicle can result in hefty fines at the end of the lease, and if the vehicle is not in top condition when it is returned, excessive wear-and-tear charges may be levied. Many dealers and financing institutions will be more lenient if you buy or lease another vehicle from them at the end of your term, but if you drop off the car and walk, prepare yourself for some lease-end misery.

Be sure to define these limitations at the beginning of the lease so that you know what you're getting yourself into. Find out what will be considered excessive in the wear-and-tear department and try to negotiate a higher mileage limit.


Benefits

By leasing, you get to drive a new vehicle every two or three years. This also means that, in most cases, the only time the car will be in the shop is for routine maintenance. And, as long as you lease only for the term of the original manufacturer's warranty, you're not liable for catastrophic repair bills. Additionally, leasing can allow a buyer to make that dream car fit the budget when conventional financing will not. Finally, and perhaps for some people this is the most important benefit, you're never again upside-down on a car loan, unless you try to end the lease early.

Studies show that consumers generally like leases, right up until they end. The reason for their apprehension is rooted in the dark days of open-end leasing, when Joe Lessee was dealt a sucker punch by the lessor on the day Joe returned the car to the leasing agent. Back then, residual values were established at the beginning of the lease, but the lessee was responsible for the difference between the residual value and the fair market value at the end of the lease. The resulting lease-end charges maxed out credit cards and dealers laughed all the way to the bank.

Leasing has evolved, and with today's closed-end leases (the only type of lease you should consider), the lease-end fees are generally reasonable, unless the car has 100,000 miles on it, a busted-up grille and melted chocolate smeared into the upholstery. Dealers and financial institutions want you to buy or lease another car from them, and can be rather lenient regarding excess mileage and abnormal wear. After all, if they hit you with a bunch of trumped up charges you're not going to remain a loyal customer, are you?

Additionally, closed-end leasing establishes a set, non-negotiable residual value for the car in advance, at the beginning of the lease. Also, any fees or charges you may incur at the lease-end are spelled out in detail before you sign the lease. All the worry is removed by the existence of concrete figures. But keep in mind that if you take your business elsewhere, you're going to be facing a bill for items like worn tires, paint chips, door dings, and the like.

Another leasing benefit is the myriad of choices you have at the end of the term. Well, maybe not a myriad, but there are four, which is more than you have after two or three years of financing. They are:

1. Return the car to the dealer and walk away from it after paying any applicable charges like a termination fee, wear-and-tear repairs, or excessive mileage bills. Of course, if you don't plan to buy or lease another car from the dealer, you may get hit for every minor thing, but those are the risks.

2. Buy the car from the dealer for the residual value established at the beginning of the lease. If the car is in good shape, the residual value is probably lower than the true value of the car, making it a bargain, and many leasing companies will guarantee financing at the lowest interest rate available at the time your lease ends. If you've trashed the lease car, compare the lease-end wear-and-tear charges to the devaluation in worth the vehicle has suffered while in your care. You might be surprised to find that it's easier and less expensive to just give the car back and pay the fines.

3. Use any equity in the car as leverage in a new deal with the dealer. Since residual values are sometimes set artificially high, the car is not likely to be worth more than the residual value at lease-end under these circumstances. But a well-maintained, low-mileage lease car might allow the dealer to knock up to a couple of thousand bucks off your next deal.

4. Sell the car yourself and pay off the residual value, pocketing whatever profit you make.

Conclusion

Closed-end leasing is a win-win situation for everybody except people who want to keep their cars for a good long time. The manufacturer sells more cars, the dealer sells more cars, and you get low payments and a new car every couple of years. However, it is important to stress that you never own the car and leasing can be quite restrictive. If you're a low-mileage driver who maintains cars in perfect condition, don't like tying up capital in down payments and don't mind never-ending car payments, leasing is probably just right for you. If you're on the road all day every day, beat the stuffing out of your wheels, enjoy a 'customized' look or drive your cars until the wheels fall off, buy whatever it is you're considering, because it will be less expensive in the long run.