Your Next Car: Should You Buy Or Lease?
This Financial Guide gives you a framework for deciding whether leasing a car makes sense for you. It explains the meaning of various lease provisions, as well as the initial, ongoing and final costs of leasing. Finally, it gives you the information you need to negotiate the best possible lease.
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Will you save money leasing a car instead of buying one? It depends on (1) what kind of deal you strike with the dealer, (2) how many miles you drive a year, (3) how much wear and tear you put on a car, and (4) what you will use the car for (i.e. personal or business use).
In order to decide whether to lease or buy, you need to consider all of the factors involved in both leasing and buying such as:
This Guide also contains a list of questions to use when negotiating with the dealer to ensure that you don't neglect to ask about any charges or lease terms that might enter into your analysis.
There are two types of lease arrangements: closed-end ("walk-away") and open-end (finance). Here's how they work:
Closed-End Leases: The Dealer Bears the Risk Of Depreciated Value
When a closed-end lease is up, you bring the car back to the dealership and "walk away." the car must be returned with only normal wear and tear, and at or less than the mileage limit stated in your lease. Since the dealer, and not you, is bearing the risk that the value of the car at the end of the lease will go down, your monthly payment is generally higher than with an open-end lease.
Open-End Leases: You Bear the Risk of Depreciated Value
With an open-end lease, you bear the risk that the car will have a certain value, called the estimated residual value, at the end of the lease. In this case, the monthly payment is lower.
When you return the car at the end of the lease, the dealer will have the car appraised. If the car's appraised value is equal to the estimated residual value in the agreement, you won't need to pay anything at the end of the lease term. Under some contracts, you can even receive a refund if the appraised value is greater than the residual. If the appraised value is less than the residual value, however, you may have to pay all or part of the difference.
Your total cost of your lease includes:
The amount of money that a dealer can collect at the end of the lease period is regulated under the federal Consumer Leasing Act (CLA). The CLA states dealers cannot collect more than three times the average monthly payment, except as follows:
The dealer also has the option of selling the car at the end of the lease term. If the car is sold for less than the residual value stated in your leasing contract, you could be obligated to pay as much as three monthly payments to make up the difference.
Your Initial Lease Expenses
The first step in deciding whether to lease or buy is to find out what your initial (upfront) expenses are. This figure is part of the total dollar amount that you will use to compare with the cost of buying with leasing a vehicle.
Initial costs are the down payment you must come up with when you lease a car and include the security deposit, first and last lease payments, capitalized cost reductions, sales taxes, title fees, license fees, and insurance. With a lease, the initial costs usually total less than the down payment typically needed to buy a car. Further, all initial costs are subject to negotiation during the bargaining period with the dealer.
As mentioned previously, the federal CLA requires the lessor to disclose all up-front, ongoing, and final costs in a standard, easy-to-read format.
Security deposit. The lessor is allowed to keep the security deposit if you owe money at the end of your lease or if you missed a monthly payment. The security deposit can also be used by the dealer to cover any damage to the car or mileage that is in excess of the limit specified in the lease. If you do not owe any money on the lease at the end of the term, your security deposit is returned to you.
First and last lease payments. The first and last months' payments are usually required to be put down at the beginning of the lease agreement. Under some agreements, the last payment might be waived if you have a good credit rating--so be sure to ask about this.
Capitalized cost reduction. This is similar to a down payment. The dealer may ask you to put a certain amount of money down before leasing. The amount of the capitalized cost reduction varies with the business custom prevalent in that specific geographic area and the credit rating of the customer. The larger the down payment, the smaller the monthly payment under the lease typically is. However, most people who want to lease instead of buy don't want to put down a large down payment, and the lack of a down payment is one of the major advantages of leasing.
Sales tax, title fees, and license fees. The CLA requires the dealer to disclose sales tax, title and license fees in writing. It also requires the dealer to tell you what type of insurance coverage is required. In addition, some states apply a "use" tax, which is similar to a sales tax, but is added to each monthly payment.
Ongoing Lease Costs
Next, you must determine what the ongoing costs of leasing are. Typically, these include monthly payments, and repairs and maintenance.
Similar to a loan, the monthly lease payment is dependent on the term of the lease, the initial "purchase price" of the vehicle and the implicit interest rate. Unlike a loan, another important factor is the "lease-end" or "residual" value. This is the expected value at the end of the lease term.
In a lease situation you are, in effect, paying for the difference between the initial purchase price and the residual value. You should negotiate the best possible (lowest) purchase price. This will lower your cost of leasing the vehicle. If this is a closed-end lease and you do not intend to purchase the car at the end of the lease term, you should also try to negotiate a higher residual value
For example, assume a car has an MSRP of $36,955 (and the lease provides for a term of 36 months, an implicit interest rate of 6.67 percent and a residual value of $25,895). Based on this MSRP, the monthly lease payment would be $481.50, excluding sales/use tax, licenses, etc. The invoice (dealer) cost on the same vehicle is $32,469 (see Info Sources at the end of this Guide to find out how to get this information.) If you negotiated a price between MSRP and invoice, say $34,750, the lease payment would be reduced to $416.00.
The CLA requires dealers to disclose the total number of payments, the amount of each payment, the total amount of all payments, and the due date or schedule of payments. There is usually a penalty for late payment, which the lessor must disclose to you as well.
Your Final Costs
Excess mileage charges. Mileage limitations usually occur with a closed-end lease. If you have gone over the allowable mileage at the end of your lease, you will have to pay a fee. With an open-end lease, although there is no penalty, if you exceed the mileage limit the appraised value at the end of the lease term will usually be lower.
Default charges. These cover any payments or security deposits that the dealer does not receive from you and legal fees and costs the dealer incurs to repossess the car.
Excessive wear and tear charges. You'll have to pay charges for excessive wear and tear when you return the car at the end of the lease unless the contract reads otherwise. The dealer must tell you in writing the specific definition of excessive wear and tear. Generally, it means anything beyond normal mechanical or physical usage.
Disposition charges. These are the costs of cleaning the car, giving it a tune-up, and doing final maintenance. If the agreement does not state otherwise, the dealer may pass these costs on to you.
Your option rights include the right to (1) purchase, (2) extend or renew, and (3) early termination.
Purchase Option. Your lease may include the option to purchase the car at the end of the lease term. This option is usually found in open-end rather than closed-end leases. Under the CLA, the dealer must tell you the estimated residual value of the car and the formula that will be used to determine your purchase price at the end of the lease.
Renewal Option. You should negotiate the right to extend or renew as part of your lease. Sometimes the lessor will reduce your cost if he knows you might want an extension of the contract.
Early Termination Option. If you terminate your lease after, say, 36 months on a 48-month lease, you will have to pay an extra charge, based on the difference between the residual value of the car at that time and the estimated residual value at the end of the lease term (stated in the contract). The difference between these two may be great. In most lease agreements, you must keep the car at least 12 months.
The CLA requires that the dealer tell you before you sign the contract whether you can terminate early, and the cost of early termination.
Here is a list of questions you may want to ask the dealer before you enter into a car lease:
There are a number of other factors that come into play in the lease-vs.-buy analysis: