How Does a Car Lease Work?

[LuckyRobin]

I am just curious as to how a car lease actually works. All I ever hear about them is don't get them, they are bad. But I would like to have someone walk me through how they work anyhow. Is there a downpayment involved? Can you set your own yearly mileage? Are you responsible for all maintenance? I just want to know the ins and outs of it, not planning on getting one. Just want to know why so many people think it is so evil?

[safari]

When you lease a car, you're paying for depreciation in car's value. They determine how much the car is going to cost at the end of the lease, and you finance the difference between the current cost and the cost at the end of the lease. For example, if the car you're buying costs $30K and in 3 years when your lease ends that car is going to cost $18K, you'll have to finance $12K for 3 years. If you have a good credit score, you can lease a car with 0 downpayment and 0 security deposit.

Lease is a good option in the following three cases:

1) When you like to drive a new car every 2-4 years. When your lease ends, you just return your car and lease a new one. There is no hassle of selling your car.
2) When you don't have enough money to purchase a new car, but still want to drive a new car. Lease payments are much lower, compared to what you'd have to pay if you bought the same car. In the example above, if you purchased the same $30K car, you'd need to come up with a $18K downpayment and finance $12K to have similar monthly payments. Of course, after 3 years you'd own that car; however, you'd have to put a lot of money down or have much higher monthly payments. Lease allows people to drive a nicer car that they wouldn't be able to afford otherwise.
3) If you own a business, you might be able to deduct all or part of the leased car cost.

When leasing a car, it's very important to know what the yearly mileage limits are. Usually the limits are either 10,000, 12,000 or 15,000 miles a year. If you exceed that limit, you'll have to pay a penalty, for example 15 cents for each extra mile. You can negotiate the yearly mileage limit at the time you sign the lease agreement, but it will cost you extra. If the car is being advertised at 10,000 miles a year, but you want 15,000 miles a year, they will raise the interest rate on your lease, called the "money factor." If you know that you're going to drive 20,000 miles a year, you can purchase the extra 5,000 miles in advance and pay a lower price, for example, 5 cents for each mile, as opposed to 15 cents when you return the car. But those miles are not reimbursable. If you only drive 16,000 miles a year, you will lose 4,000 miles.

You're responsible for maintaining the leased car and performing regular oil changes. When you return thy car at the end of the lease, the dealer will inspect it, and if they find anything wrong with it, outside of normal wear and tear, you'll be assessed a penalty. Each dent or scratch will be measured, and the penalty will depend on the size of those dents and scratches. If the tires are worn out, the dealer will charge you a fee for each worn tire.

If you have any other questions about car leases, please feel free to post them here.

[LuckyRobin]

Thanks, that is helpful.

[disneysteve]

Originally Posted by LuckyRobin

I am just curious as to how a car lease actually works.

Just want to know why so many people think it is so evil?

safari did a nice job of answering the first part of your question. Let me take a stab at the 2nd part.

Leases are bad news exactly because of what safari said.

They allow, even encourage, you to get a new car every couple of years which is a tremendous waste of money.

They allow, even encourage, you to get a new car rather than a used car, also generally not a wise financial decision.

They allow, even encourage, you to get a nicer, more expensive car than you can really afford. It is always better to live within your means, not use "creative" financing to live beyond your means.

They allow, even encourage, you to buy a car with little to nothing down rather than saving for what you want, the old-fashioned way.

It makes perfect sense to rent a car when you will only need it for a few days or a week or two, like when you are on vacation in a distant town. It rarely makes sense to rent a car for everyday use for 3 years.

[LuckyRobin]

Okay, Steve or Safari, so say you leased it for two years knowing that in two years time you would have a lot more disposable income and would then be able to buy it at the end of the lease. In that instance is it worthwhile or do you just end up paying far more than you ever would have if you'd just bought the car financed in the first place? Would you be paying for more than the car was now worth at that point?

Is it ever a good idea to lease for two years and then buy the car?

[safari]

Originally Posted by LuckyRobin

Okay, Steve or Safari, so say you leased it for two years knowing that in two years time you would have a lot more disposable income and would then be able to buy it at the end of the lease. In that instance is it worthwhile or do you just end up paying far more than you ever would have if you'd just bought the car financed in the first place? Would you be paying for more than the car was now worth at that point?

Is it ever a good idea to lease for two years and then buy the car?

When you lease a car and then buy it at the end of the lease, you'll be paying more money in the end, compared to what you would have have paid if you bought that car without the lease. However, the difference may not be very big, depending on circumstances. Car manufacturers may offer special lease rates with the interest rates lower than the rate you would get when buying a new car. But you need to make sure that it's an "open end" lease, which means that you have an option to buy the car at the end of the lease. That won't be possible with a "closed end" lease. You also need to keep in mind that if you're planning to finance your car when you buy it at the end of the lease, it will be considered a used car, so the loan interest is going to be higher if you decide to finance it. If you know for sure that you will be buying the car at the end of the lease, you won't need to worry about the mileage. However, on the flip side, if you drive a lot of miles, your car will depreciate faster, and the purchase price that you will have to pay at the end of the lease might be higher than the Blue Book value of your car. How would you feel about overpaying for a used car, if you could buy a similar car for a lot cheaper? My car has very low mileage, only 19,500 after 4 years of driving, so I am going to exercise my option and buy it in November when my lease expires. When I leased my car 4 years ago, I wasn't planning on buying it, but when the Blue Book dealer trade-in value is $28,000 and I have an option of buying my car for $20,000, buying makes a lot of sense.

Here is something else you might find helpful. As you know, when you lease a car, you're paying for its depreciation. The depreciation is calculated by subtracting the residual value from the purchase price. The residual value is what they estimate the car is going to cost at the end of the lease. In other words, that will be your purchase price if you decide to buy when your lease ends. The residual cost is calculated by multiplying the sticker price (MSRP) of the car by a set percentage. For example, if they estimate that the car with the sticker price of $30K will retain 60% of its value in 3 years, the residual cost is going to be $30K * 0.6 = $18K. Here is where it gets interesting. Note that the residual value is calculated off the sticker price and not the purchase price, which means that the lower price you negotiate, the more sense the lease makes. If you buy that car for $25K, the depreciation is going to be $25K - $18K = $7K, but if you bought that car for $28K, it would have been $10K, which is a 30% difference. Now you might ask, what if you just bought the car, wouldn't it be the same? Not even close! The difference between buying a $28K car and a $25K car is only about 11%. In conclusion, when leasing a car, look for one that holds its value well (doesn't depreciate much) and that can be bought for the price close to invoice or maybe even lower (look for incentives).

[LuckyRobin]

So something like a Toyota Prius would be a good car to lease then? Because I see two year old Prius's selling for close to the price of new, usually within $2000 to $3000 of what a new one would cost.

[safari]

Originally Posted by LuckyRobin

So something like a Toyota Prius would be a good car to lease then? Because I see two year old Prius's selling for close to the price of new, usually within $2000 to $3000 of what a new one would cost.

Yes, exactly. Imagine if cars appreciated in value, then you would have gotten paid for leasing a car

[DebbieL]

Are they actually getting that price for the used Prius or just asking for that much? I ask that because where I live, people want ridiculous money for their used cars. I could go to Alberta and pick up a nicer car for way less. Asking isn't getting. Just curious.

[safari]

Originally Posted by DebbieL

Are they actually getting that price for the used Prius or just asking for that much? I ask that because where I live, people want ridiculous money for their used cars. I could go to Alberta and pick up a nicer car for way less. Asking isn't getting. Just curious.

Even though the prices that people asking for their used cars are a good indicator of how well the car holds its value, you should find out exactly what the residual values are that the dealers are using. Those residuals are non-negotiable and are set buy the car manufacturer. The residuals only depend on the year and model of the car and the yearly mileage limit. I highly recommend visiting forums at Edmunds where they have special forums dedicated to leasing, and where you can ask questions. Here are some helpful links for you:

Toyota Prius: Lease Questions
Toyota Prius: Prices Paid & Buying Experience

[eisor]

Thank you sooo much!!! I too had the same questions as LuckyRobin and this post just cleared up a lot!!

My DH and I have toyed around with the idea of leasing a Toyota or Honda and while making the lease payments saving up the rest of the money to buy it outright at the end. Then, when the lease is up, we'd buy the car. So, your information has really helped me understand the process a lot more.

[safari]

eisor, you're very welcome. Glad I could help.

[LuckyRobin]

The used Prius's I see have all been at the dealers and they have all sold within a week, if not within a few days, of hitting the websites. I've talked to the two dealerships and they both have said they can't keep a used Prius on the lot. They just go so fast at asking price. I don't know what people are doing, just what our local dealerships are doing.

Thanks so much, I really feel like I understand the process now and can approach it in a common sense way if it turns out to be an option that my DH and I choose to pursue at some point in the future. Knowing what cars to do it with and what cars not to do it with is half the battle.

[MikeMedcheck]

"Safari" is right about the way that it works but you left out a few important details.

1. Choosing the right automaker to lease from can have a tremendous impact on your payment and a few other factors. For example; the value at the end of the lease is called the "residual" value and some makes will have a lower residual value than others. Toyota's generally have the highest around 55-60% while Chevy and Ford will be around 30-40%. This matters because the less depreciation on the vehicle the lower your payment will be.

2. A lot of times especially with vehicles that have high resale values you can have equity in your lease. Let's say that 18 months into a 36 month lease your payoff on the vehicle is $14,000 but the vehicle is worth $18,000. You can trade this leased vehicle in and you now have $4000 of equity. Another equity example is this; say that your residual value is $10,000 and when you get to the end of your lease your vehicle is worth $12,000 and you are over your miles by 3,000. Most people in this situation would panic because they think that they will have to pay a penalty for those miles but what most people do not know is that if you buy the car at the end of the lease you do not have to pay for those miles. You only have to pay for going over your miles if you turn the lease in.

3. You cannot be upside down in a lease. If your residual value is $10,000 at the end of your lease but your vehicle is only worth $8,000 you will not have to pay the difference.

Leasing is designed not only to help you get a lower payment but it's designed to work for you. When you finance a vehicle you lose any equity that you could have gained by leasing. So for those of you that say that you are throwing your money away by leasing, you obviously have never tried it because I lease a new vehicle every 3 years and every time I do it my payment gets lower and lower because I use my equity to my advantage.

[photo]

Originally Posted by MikeMedcheck

When you finance a vehicle you lose any equity that you could have gained by leasing.

You have zero equity in the car that you're leasing. Equity implies ownership, and you're only "renting" the car. Your payments probably are lower because the company leasing the car wants to encourage you to keep leasing because it's highly profitable to them -- not you.

[greenskeeper]

How Does a Car Lease Work?

They take your money AND the car when it's all done

[disneysteve]

Originally Posted by MikeMedcheck

you can have equity in your lease. Let's say that 18 months into a 36 month lease your payoff on the vehicle is $14,000 but the vehicle is worth $18,000. You can trade this leased vehicle in and you now have $4000 of equity.

I lease a new vehicle every 3 years and every time I do it my payment gets lower and lower because I use my equity to my advantage.

Is there any penalty for breaking the lease? Wouldn't that count against any "equity" you have?

The fact that you lease a new car every 3 years and your payment keeps getting lower just means one thing - you take on a new car payment every 3 years. How long have you been doing that? How long have you had perpetual car payments? I bought my car used in 1998 and paid it off a couple of years later. I've had ZERO car payments for about 10 years now. We bought my wife's van used for cash in 2002 so have never had a payment on that and it has been over 9 years. Who made the wiser financial move here?

No matter how you try to spin it, leasing is a waste of money. It is by far the most expensive way to drive a car.

[Shewillbemine]

A. Not another 4 year old thread revival.

The general consensus is always that leasing is not the cheapest way to have a car and in the long run, always more expensive than buying/loaning. However, for people who deem it worthwhile to own a new car every few years, leasing can be the smarter route.

Look, if our position on this forum is save every single penny, then yes, buy yourself a $1000 vehicle and be done with it. But if you are solvent and can write off a car lease as a business expense, it isn't out of the question.

The problem with forums is that everyone is dying to give absolute advice but everyone is different. My millionaire boss who leases his expensive vehicles? Yeah, he's fine.

Steve, It's admirable that you don't have a car payment and drive a 10 year old car, but not everyone wants that. Others might tell you "why do you have a computer or pay for internet?". Remember, only a Sith deals in absolutes.

[photo]

Originally Posted by Shewillbemine

A. Not another 4 year old thread revival.

Well, at least the person replied more than just saying, "Yeah, great advice," and left it at that. Sometimes I don't think people pay attention to the dates at all.

The problem with forums is that everyone is dying to give absolute advice but everyone is different. My millionaire boss who leases his expensive vehicles? Yeah, he's fine.

But does your boss frequent these forums and ask for advice? Probably not. You're right that we all have different wants and needs. However, for the average person who doesn't have a multi-hundred-thousand-dollar-a-year salary --and-- is trying to save money (which is the raison d'être for these forums), leasing is almost always a very poor option. The one exception that comes to mind is if a person will be working overseas for a relatively short period of time, then it may be more cost effective to lease a car for a year rather than shipping one's own over the Atlantic or Pacific. And then again, maybe it's cheaper to ship the car, I don't know.

[disneysteve]

Originally Posted by Shewillbemine

for people who deem it worthwhile to own a new car every few years, leasing can be the smarter route.

I suppose that's true but I would disagree with the premise.

Look, I'm glad there are people who buy/lease new cars every couple of years. That's what creates the supply of gently used cars for the rest of us to buy. But if somebody comes asking my advice, I'm never going to tell them to lease a new car.

if you are solvent and can write off a car lease as a business expense, it isn't out of the question.

I'm not an expert on the tax issues here but I have heard that leasing through a business can make sense so I won't argue that point. That isn't what people here are typically asking about, though. Most are asking about personal leases.

The problem with forums is that everyone is dying to give absolute advice but everyone is different. My millionaire boss who leases his expensive vehicles? Yeah, he's fine.

I agree. We all tend to spout rules of thumb with the unstated understanding that it is general advice applicable to the average person. Those rules of thumb, however, don't apply to everyone. Take car buying, for example. The rule of thumb is that if you must take a loan, the payment shouldn't exceed 10% of your income for no more than 36 months. That's great if you earn 50K but if you earn 500K, that limit is ridiculous. So your boss is spending probably far less than 10% on his car payment even if he is leasing. I've got no problem with that. Even Dave Ramsey (who is pretty extreme) says that you shouldn't be buying a new car unless you're a millionaire, so he recognizes that at some point, the rules of thumb don't apply.

Steve, It's admirable that you don't have a car payment and drive a 10 year old car, but not everyone wants that.

Fair enough, but when asked for my advice, I'm going to give it based on what I would do in a given situation. Anything else would be hypercritical.