Leasing a car is the area of most confusion when it comes to purchasing a new car. Most people don’t have a clue how leasing works and thinks it’s a bad way to get a car. Actually, it can be one of the best. Let’s see if I can simplify leasing a car. Let take for example when you finance a car and at about the 3-year mark you decide to trade it in for a new car. The dealer gives you a trade in value toward the new car and depending on what you owe on your car its either works for you or against you. When you lease a car the bank actually promises to buy the car back at a pre-determined value. As long as you take care of the car, don’t destroy the car inside or out or go over the agreed mileage the bank will buy the car back from you at the predetermined value and you walk away owing nothing, zero, nada. If you want another car and your car is worth more than the trade in value it will reduce the cost of the new car. So, for you do things correctly it’s a win win win situation for you. If you are a high mileage driver who puts more than 15,000 miles per year on a car or you just don’t take care of your vehicles then leasing is NOT a good option for you.
So how does leasing work. How is the payment calculated? When financing a car there are 3 variables to get to the payment – the cost of the car, the length of the loan, and the interest rate. In leasing there are four, the extra is what is called a residual value of the car. In other words, what is the predetermined value at the end of the lease. This is usually a percentage of the MSRP. For example, my 2012 Honda Accord had a residual percentage of 57%. The MSRP was $23,070 and the residual was $23,070 x 57% = $13,150. When calculating the payment I do not pay any principle towards the $13,150. When I was negotiating the price of the car with the dealership, I negotiated the purchase price down to $18,841. That did not affect the residual value. The residual was still based on the MSRP not my purchase price. Here is the formula to calculate the payment.
(Purchase price (cap cost) + residual value) x money factor (equivalent interest rate/24) = A
(Purchase price (cap cost) – residual value) / length of lease = B
Add A+B = the payment before sales tax.
Cap cost is the final negotiated purchase price including bank and dealer fees, tire fee, title and licensing fees, minus the trade in and down payment money. It is the amount you are financing into the lease.
The key is to know the formula and the money factor so you don’t get taken advantage of. You must know all of these numbers BEFORE you lease the car. Make sure they disclose them to you. With this formula you can double check the lease payment to make sure something else didn’t get added into the cost of the car after negotiations. The dealers used to, many years agao, be able to hide the info from you but they can’t anymore. The current interest rate on leases is between 1% - 2%. When I leased my car it was 1.56%. The biggest advantage is the dealer or leasing company takes the risk of the depreciation when you drive it off the lot, not you. Also the maintenance and expenses are the same whether you buy or lease the car. Gas costs the same, repairs cost the same, tires cost the same. The car is the same car whether you buy or lease. My lease with a few optional bonuses is $220 per month with 15,000 miles per yr. AND in my case it had a 3 yr/36,000k mile bumper to bumper warranty. They even replaced the battery that failed at about 35,000 miles/30 months.
Next the pros and cons between options
Roger – Your Money Coach