If you've paid attention to car commercials on television lately, you may have noticed there are some jaw-dropping deals on auto leases – or so it seems. Some sharp entry-level sedans carry monthly payments as low as $150.
But the first rule of shopping for any kind of car, whether for purchase or for lease, is to forget the monthly payment and instead, focus on the purchase price, interest rate and the length of time you'll be making payments.
“Unfortunately, I think most people define affordability by how much the monthly payment is,” said Mike Sante, managing editor of Interest.com. A lot of people think, if the check doesn't bounce I must be able to afford it.”
Sante and his team conducted a study in February and concluded that most consumers can't afford most new cars. And that's part of the seductive appeal of an auto lease – it looks much cheaper than buying. The monthly payment is lower and so is the down payment.
Paying for just part of the car
That's because, with a lease, you aren't paying for the entire car, just the part that you're using. In a typical lease, you surrender the car at the end of three years. The car still has a lot of its value left, which the lessor recoups when they sell the vehicle on the used-car market. You are only paying for the first three years worth of value.
But are you overpaying? That's the question you must answer before deciding whether leasing a vehicle is right for you. Often, it depends on the kind of vehicle and the price.
Let's look at two different vehicles and approach them from both a lease and sale perspective.
Before going any farther, let's get business leasing out of the way. Many businesses, both large and small, lease their vehicles because they can deduct the entire lease payment from their taxes. We're ignoring that in this discussion, which is intended striclty for consumers.
A pricey ride
We'll start with an expensive car, like the Audi S5 coupe.
To lease the vehicle, the dealer determines how much depreciation should occur from the $50,900 MSRP when it's in the showroom until you return it three years later. The dealer applies an interest rate and amortization schedule, adds in some other fees and charges, and comes up with a monthly payment.
To purchase the same car a consumer would have to put down as much as $10,000, with the monthly payment reflecting the full value of the vehicle.
For that reason the buyer would likely be making payments longer than three years. Some payment plans for a car in this price range could easily extend six or seven years.
The Chevrolet Cruz, with an MSRP of $17,130, would most likely carry a much smaller lease payment but would lose a greater percentage of its value than the Acura.
To purchase the Cruz you would need a down payment of no more than $2,500 and the montly payment, while higher than a lease payment, might only be for three or four years. At the end of that time you would own the vehicle. So it would seem a lease probably makes more sense for an expensive car and less sense for an inexpensive one.
But many personal finance experts say it depends on a lot of factors. Do you change cars every three or four years or do you drive one until the doors fall off? If it's the latter then buying is a better deal. But if you change your wheels more often, then leasing starts to look like a better deal.
Just like buying, it only becomes a good deal if you negotiate one. Many consumers don't realize that a dealer will negotiate a lease, just as they would a sale. To dealers, there's very little difference. The consumer should view it the same way, and that means not paying so much attention to the monthly lease payment, which is what the car commercials flash on the screen.
Three things
Instead, there are three things you should pay attention to. The first is the “capitalized cost.” This is what you and the dealer agree that the vehicle is worth right now. Just as if you were buying the vehicle, you want to negotiate the number as low as possible.
The second is the “money factor.” This translates into the cost of financing. The entity leasing the vehicle has to purchase it before they can lease it to you. This is the cost of the money they use.
The third factor is “residual value.” This is what the parties agree will be the value of the vehicle at the end of the lease. A high residual value will result in lower payments but make it more expensive for you to purchase the vehicle at the end of the lease. If you want to trade the vehicle before the lease is up, it reduces a lot of your flexibility.
Yes, it is possible to trade in your leased vehicle before the term is up without taking a bath. Websites like SwapALease.com and LeaseTrader.com, where consumers can find other consumers to take their car and take over the lease payments, have in recent years, added more flexibility to leasing.
What to do
In the end, the problems many consumers face with an auto lease are caused by not completely understanding how they work. Leases are different from a sale but not that much different. By focusing on the bottom line – what the vehicle actually costs – the consumer has a better chance at a satisfying lease deal.
That means doing your homework on the car before ever setting foot in the dealership, just as you would do if you planned to purchase it. Checking automotive sites like Edmunds and Kelly Blue Book will help you arrive at that all-important number – what the car should cost.