Auto Leasing: Look Before You Lease
Many people get stuck with a car they no longer want, or a car they can no longer afford, because they got talked into leasing by a car salesperson. If you ever consider the two options of either obtaining an auto loan or a car lease, make sure that you understand all of the numbers and all of the provisions in the lease agreement, especially since most lease agreements are prepared by the dealer.
One thing to consider is the difference in the cost between the two options. For example, let's say you have the option to lease a new Mercedes-Benz for 27 months with a monthly payment of $652. When you lease, you will have to pay the first monthly payment, the amount of any capitalized cost reduction, title fees, registration fees and other miscellaneous fees, such as document fees, at the time you sign the lease. This could amount to an upfront cost of almost ten percent of the agreed upon value of the car. This agreed upon value is referred to as the capitalized cost. Any amount that reduces the capitalized cost, such as any net trade in allowance, rebate, cash that you pay or other credit is called the capitalized cost reduction. By deducting the capitalized cost reduction from the gross capitalized cost, you will arrive at the adjusted capitalized cost which is the amount used to determine your base monthly payment.
In this example, if the gross capitalized cost is $55,000 and the capitalized cost reduction is $4,000, the adjusted capitalized cost is $51,000. This is the amount used in calculating the base monthly payment. From this amount, you deduct the residual value, which is the value of the vehicle at the end of the lease term. If the residual value is determined to be $40,000, you would deduct the residual value from the adjusted capitalized cost to arrive at the depreciation of $11,000, which is the amount charged for the vehicle’s decline in value over the lease term. The dealer will typically add on a rent charge, which is an amount charged in addition to the depreciation. If the rent charge were $5,000, the total amount charged for all monthly payments would be $16,000. By dividing $16,000 by 27 (the total number of payments), you get $592.59, which is the base monthly payment plus sales taxes of approximately $60. The total monthly payment would be $652 for 26 more months in addition to approximately $4,750 due at signing. At the end of the lease term, you would typically have the option to either purchase the vehicle for the residual value of $40,000 plus a purchase option fee (could be about $150) or return it to the dealer and pay a vehicle turn in fee (could be $500 to $600) plus any amount owed for excess wear and tear and/or any amounts unpaid or past due.
If you were the type of person who likes to keep a car for a long time, even after the loan is paid off, then buying would most likely be the least expensive option. If you financed the Mercedes-Benz for five years at 4.9% (with a down payment of $4,750), your loan payments would be about $945 per month but after five years you would own the car.
If you ever decide to lease a car, make sure you understand the terms and all of the numbers used to calculate your monthly payment and the total amount due at signing. The amounts are negotiable. For example, you can negotiate the gross capitalized cost (the agreed upon value of the vehicle) for a lease just as you would negotiate the sale price with a purchase. Keep in mind that the residual value is the value of the vehicle at the end of the lease. Your monthly payment will be lower with a higher residual value, but you may not want to buy the car at lease end due to the higher cost.
Before you get locked into an auto lease, make sure you understand all of the provisions in the lease agreement. Avoid cosigning a lease agreement with someone else. Likewise, avoid letting someone cosign a lease with you. Once you sign a lease, you are pretty much stuck for the entire term of the lease. Anything can happen in life, including death. Suppose that in the preceding example, someone such as a spouse cosigned the lease agreement. If the primary lessee passes away, or becomes disabled or whatever, after say 17 months or any time before the end of the lease, the cosigner will be entirely responsible for making all monthly payments and all other charges through to the end of the lease. There is no easy way out. The cosigner would have the same options to either purchase the vehicle at lease end or walk away. But, what if the cosigner does not need the car? What if the cosigner cannot afford the payment? In the example above, a cosigner could continue making the monthly payment of $652 through to the end of the lease, return the vehicle early and pay an early return of vehicle charge of approximately $6,700 or try to find someone to take over the payments. But again, an inflated residual value could make it more difficult to find someone to take over the lease, as in the case described above, since it would be more expensive for him or her to buy the car at the end.
In sum, your payments will generally be lower with a lease, since the monthly payments are based on the depreciation of the vehicle in addition to other fees and expenses. However, your overall cost could be higher, especially if you decide to buy the vehicle at the end of the term, due to the high residual value and other costs built into the lease. When you buy, your payment is based on the full value of the vehicle, less a down payment or trade in allowance but you own the vehicle at the end of the term.
Above all else, make sure you understand all of the numbers, how the payment is calculated, the residual value and what happens if you want out. In most cases, with an auto lease, you are stuck for the entire term of the lease. And, be careful about cosigning a lease or having someone cosign a lease with you.
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