Auto Leasing On the Rise

When in the market for a new car, people have the option to buy or lease their ride. The Early Show's financial guru, Ray Martin, explains why leasing is becoming increasingly popular, and weighs the pros and cons of signing a lease.

J. Paul Getty once said, "If it appreciates, buy it. If it depreciates, lease it." When it comes to automobiles, at the moment, more people are taking his advice.

After several years of decline, last year nearly one in five new car buyers chose leasing, a 21-percent increase from the previous year, according to Edmunds.com, the popular automotive Web site. But most folks who buy a car know that over the long run, they end up paying more in total payments when they lease versus buying and owning the same car for a long period of time.

So what's driving the increase in leasing these days? First, interest rates on the types of loans people used for buying an automobile have increased considerably over the past several years. And with tighter budgets — interest rates on home equity loans stand at about eight percent on average, up over five percentage points since 2004, and higher fuel prices — leasing provides an alternative that over the short term provides a lower monthly payment. Finally, as more new cars include new options such as iPod connections and on-board GPS guided maps, the urge to trade-up is almost irresistible.

There are several reasons why leasing is attractive to many drivers, some of which are:

  • Less Cash Upfront: Most leases require little or no down payment, which makes getting into a new car more attainable for cash-strapped buyers or frees up your cash for other things.

  • Lower Monthly Payments: Because you're only paying for the portion of the vehicle that you actually use, your monthly payments can be more than 30 percent lower than the payments for a typical loan you would need to buy the same vehicle.

  • More Car, More Often: Since your monthly payments are lower, you'll be able to get more car for your monthly payment and drive a new car every two to four years, depending on the length of your lease.

  • Lower Sales Tax: In many states, you only pay sales tax on your monthly lease payments, instead of on the entire value of the vehicle.

  • Fewer Maintenance Headaches: Many people lease for a term that coincides with the length of the manufacturer's warranty. This ensures the vehicle is always covered under the warranty.

    Also, with leasing, the headaches of selling a used car are eliminated. When your lease ends, you can simply return it to the leasing company and walk away, or you can buy it.

    The Language Of Leasing

    Leasing is very similar to taking out a loan to buy a vehicle, but there are two important differences: First, the dealer sells the car to a leasing company, and second, you must return the car at the end of the lease term. The concept of leasing is fairly simple, yet many consumers don't understand it and are skeptical of it.

    The key to getting a good deal on a lease is to know how an auto lease works. With leasing, you only pay for the amount that the vehicle depreciates. For example, if you lease a car that costs $30,000 that will be worth $18,000 after 36 months, you only pay for the $12,000 difference, plus interest. You'll also need to add a few new words to your vocabulary to drive a good deal on a lease, like:

    Cap Cost = Price of the Car (lower is better)
    Always focus first on negotiating the lowest price of the car when you are leasing. The cap cost is the price the dealer will sell the car to the leasing company. The lower you can negotiate the price of the car the lower your monthly payments will be.

    Cap Cost Reduction = Down Payment (lower is better)
    You can choose to make a down payment or apply a trade-in, customer rebate or factory-to-dealer incentive towards the cap cost. This lowers the cap cost and will lower your monthly payments. But it's typically in your best interest to put as little down as possible when you lease. That's because big down payments can be risky, as you are simply pre-paying some of the lease's monthly payments. If the vehicle is totaled or stolen, your insurance company will pay off the remainder of your lease (assuming you have gap insurance), but the finance company will keep your down payment.

    Residual Value = Price of Car at Lease End (higher is better)
    This is the price the leasing company figures they can fetch for the vehicle at the end of the lease term. This will also determine your monthly payments because the difference between the cap cost and the residual value is the portion of the vehicle's value you are paying for during the lease term. The higher the residual value is, the lower the monthly payment. The best vehicles to lease are those with residual values around 60 percent or more of their original price after 36 months. To find out the residual values of many vehicles, check out the Black Book online at www.alg.com (Automotive Lease Guide), or a hard copy at your local bank's auto loan department.

    Money Factor = Interest Rate (lower is better)
    Another factor in negotiating a good deal on a lease is a term called the "money factor" or "lease factor." This is the interest rate, though in leasing it's expressed as a small decimal number. To calculate the equivalent annual interest rate, multiply the money factor by 2,400, regardless of the length of the lease. A money factor of 0.00229, for example, would equal 5.5 percent. The interest charge is rolled into the monthly payment, so the lower the money factor, the lower your monthly lease payment.

    Lease Term = Length of Contract
    This is the number of months you are expected to make the lease payments. Always ensure the lease term is no longer than the vehicle warranty.

    • Daniel Schorn

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