If there’s one factor that defines the modern commercial world, it would be financial flexibility. This is perhaps best represented in the world of car leasing. You can opt to either buy or lease a car, depending on your needs, since car purchases can be pretty expensive if you’ll only use it for a short while.
Those who wish to lease a car will benefit from lower monthly payments, lesser repair costs, and being able to drive new cars more often. If you want to try leasing a car but are still unsure on how a lease works, you should read our article here. In today’s piece, we are exploring car leases in detail, creating a comprehensive guide to new and existing car leaseholders alike.
What is a Car Lease?
A car lease, also known in some places as a contract purchase, is a special kind of auto financing that allows you to take a new car away from new car dealerships with you as the principal driver, but not as the actual owner of the car. In a sense, it’s a new way of renting a car for a longer period of time.
To be clear, this isn’t like a holiday rental where you borrow the car for a week while you are traveling. A car lease typically lasts for three years, and involves paying a pre-agreed monthly rate. At the end of the lease period, a number of things can happen:
- You can return the car to the dealership
- You can return the car to the dealership in exchange for a new model on similar or perhaps the same terms
- You can purchase the vehicle by making a final payment
The main idea behind car leasing is that it allows you the benefit of driving a brand-new car, but without paying the full cost of ownership. In a car lease, you generally just pay for the depreciation cost of the car before then returning it to the dealership. Having recouped the depreciation (plus fees), they can sell the car as a pre-owned model and clear a profit overall.
So, as the holder of the lease, you can drive the car and use it as your own, but there are also some binding limitations that are written into your lease agreement. For example, you are not the owner of the car, so you aren’t entitled to add a custom paint job or make other modifications to the car. In addition, you can’t sell the car if you’re short of money, since you are not in any legal sense the car’s owner.
In a typical lease, you pay a monthly fee that is based on numerous factors (see more below), and you agree to follow a maximum annual mileage and to look after the car to prevent unnecessary wear and tear. When you ultimately return the car, you can be charged extra if you have exceeded the annual mileage limit, or if you have damaged the car in some way.
How is a Car Lease Structured?
Before we get into the structure of a car lease, it’s important that you first become aware of some key vocabulary:
- Open-end and Closed-end lease: The former means that you and the dealership have not determined the car’s value at the end of the lease period. At the end of an open-end lease, you can get money back if it turns out the current value is more than it should be for the given time. Conversely, you can also have to pay more if it’s worth less. A closed-end lease means you’ve agreed that value and thus any additional charges can only be based on violating other conditions in the contract as mentioned in the section above.
- Capitalized cost: This refers to the value of the car plus the value of any other services and fees defined in your leasing agreement.
- Residual value: The value of the car at the end of your leasing agreement.
- Depreciation: The rate at which your leased car loses its value over time.
- Rent charge: This where the cost of leasing comes in; it’s a bit like interest on a car loan. It’s how the leasing companies make their money.
- Use tax: Some states in the US apply a “use tax” when you take out a car lease, and is levied in lieu of a sales tax.
- GAP insurance: Guaranteed Auto Protection covers how much you owe vs. the lease value in the event that the car is stolen or written off.
Calculation of Monthly Payment
The monthly lease payment is not an arbitrary number, but rather the result of a calculation that goes a little something like this:
Step 1: Start with the MSRP of the vehicle, and multiply by the residual percentage, which gives you the residual value.
Step 2: Add in any and all fees that the customer has to pay. This gives us the gross capitalized cost.
Step 3: Now factor in the capitalized cost reduction, which comes in the form of your down payment, any trade-in equity or additional subsidy or rebates that apply. Subtract that total from the gross capitalized cost to get the adjusted capitalized cost.
Step 4: Subtract residual from the adjusted capitalized cost – this gives us the amount of depreciation, and that is the basis of the lease payment.
Step 5: Divide depreciation by the number of months in the lease — it could be 24, 36, 48, for example — and that gives you a base payment.
Step 6: Next, we need to add the rent charge tot his base payment. We get the rent charge by adding the adjusted capitalized cost to the residual and then multiplying that by the money factor.
Step 7: Add the rent charge and you have a pre-tax lease payment. Add taxes and then you get your total.
Credit Score and Car Leases
Another critical factor in car leasing is your personal credit score. According to data from Experian.com, the average credit score used to gain car leases during 2020 was 729. This score is well within the “Prime” level of credit, which ranges from score 661 to 780. Does this mean that that you have to be within the “Prime” band to gain a car lease? Actually, no.
Car leasing is possible at different credit levels, but the natural result of a lower credit rating is that the chance of refusal increases, and the likelihood of less favorable terms in case of acceptance increases. Your choice of models will be greatly limited, and monthly payments are likely to be higher if you have poor credit. There will also be much less flexibility.
What to Consider Before Leasing a Car
There are three crucial things you should think about before you even contemplate signing any car lease:
You must know everything you can about the vehicle you intend to lease. You should try to apply the formula mentioned above to try and work out a reasonable leasing rate before you inquire. This way, you know if a leasing deal is fair or not.
It’s a good idea to maintain some flexibility when you’re exploring available car leases, especially if it’s your first time. Managing a lease successfully can help to boost your credit rating, so accepting something lesser in the beginning might be a good stepping stone to your more ideal car on better terms further down the line.
Remember that nothing in the world of leasing is immediately set in stone. Dealerships are competing in a cut-throat marketplace to get signatures on leases. This gives you an advantage. Be ready to shop around and find the best car deals on cars you are interested in.
The Pros and Cons of Car Leasing
Like anything else in life, there are good and bad points to car leasing. Some will extol the advantages to no end, while others will be fiercely critical of leasing and advise you against it. The key is thinking on the following pros and cons and then deciding if leasing is right for you.
Pros of Car Leasing
Let’s start positively with the advantages:
You Get New Cars
Cycling through car leases sees you consistently driving the very latest thing on the market. Just as you hit the three-year mark and the car is starting to get old in comparison to the newest offerings, you can get yourself upgraded back to the cutting edge.
Reduced Maintenance Costs
A natural result of driving the newest cars is vastly reduced maintenance costs. Many of the more expensive maintenance jobs are not required in most cars until after the third year has passed. By then, you’re already receiving your next model, which means you aren’t paying as much as regular car owners have to.
Leasing is a great option for those who want their own car on good terms and for a significant period, but not forever. Buying, registering and then ultimately selling and transferring a vehicle is a real pain. If you are in a place for a fixed amount of time, perhaps on a work contract, then a car lease is ideal, giving you the flexibility and reasonable price, but also creating a simple mechanism through which to hand back the vehicle at the end.
Cons of Car Leasing
With ever silver lining unfortunately comes a cloud.
Leasing means you don’t actually own the car. For some, this leads to additional anxiety for when things go wrong. If you damage the car, you could be liable for huge extra charges, even if you repair the immediate problem yourself.
Limits on Driving
Car leases typically feature annual mileage limits, which can be hard to predict for some. If you have the luxury of knowing exactly how far you’ll drive each year, then it works, but for the many who don’t, it’s a problem. Exceed the limit and you’re charged per mile.
It may feel like you pay less in the short term because you only cover depreciation and it’s all condensed into that neat monthly rate. In fact, you often end up paying more than you should for what you are getting in reality. Those first few years of the car’s life are when they depreciate the most, and that’s what you’re paying for.
Conclusion: How to Get the Best Lease Terms
When you understand all of the above, it should start to become clear how you can maximize your benefit when leasing and get the best-possible terms. Just in case it’s not clear yet, here are some pointers to wrap up today’s article:
1. Boost your credit rating before you lease. A higher credit rating means you get better terms, so building credit before taking on a lease is a great idea.
2. Think about leasing a used car. Since depreciation slows down after the first 2-3 years, leasing a car that is 2-3 years old means that the depreciation you’re paying for is a lot more reasonable in value. It could mean additional maintenance costs, though, so you have to balance that out.
3. Shop around. Never take the first lease deal you are offered, no matter how good the terms look. Remain open and flexible to other options, explore other local car dealerships and find the best things on offer.
4. Negotiate. Finally, don’t shy away from negotiating the terms as much as you can. Try your best to tailor the agreement to suit your particular situation. Don’t feel as though you have to be the one to mold to what the dealership wants to sell you.
Be sure not to miss our next blog in our blog page, in which we will continue discussing car leases, specifically how you can terminate leases early.
If you want to lease or buy a new car, you will need to look for the best car dealership to ensure that you’ll get the best deal and haggle-free experience. Because the lease price is primarily based on the car’s price, CarBevy can help potential car buyers get the car they want or need at the price point that they’re willing to pay. Visit www.carbevy.com to learn more.