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 Whether or not you decide to own or lease an automobile is as much a lifestyle decision as it is a financial one. Whenever making a major investment decision, as in the case of buying a car, many people simply prefer to lease rather than own.
In fact, there are lots of people that lease their vehicles and most of them simply like the idea of driving a new automobile every couple of years. It's also a good option for those just starting out in the working world that simply cannot afford to commit a lot of money to a large down payment on a car right now, but expect their salaries and lifestyles to grow quickly into that range of affordability.
Leasing an Automobile
In this series of articles, we are going to cover the more important points that will help you decide if leasing a car is the right decision for you. Later in this series we will take a closer look at some of the finer points of leasing versus buying a car. But let's get started with the easy stuff - the basics of how car lease payments are calculated.
Leasing versus Owning a Car
When you lease a car, you never own the vehicle. Of course you can use the car, but you must return it to the lessor at the end of the lease term. When you take out a car loan, you're financing the car's purchase and you are taking full ownership of the automobile only after you've completed your financing obligation - all your monthly car loan payments have been made.
When you buy a car, you will typically have to pay up-front costs such as a down payment, sales tax, and registration fees. In a lease, you will have to pay a security deposit, the first month's payment, capitalized cost reduction, sale tax and registration fees. Since you never own the vehicle with a lease, the true owner - the lessor - needs to be sure that when the vehicle is returned the excessive wear and tear or small damages can be paid for and repaired. This is the reason a security deposit is taken.
Car Lease Calculations
The capitalized cost reduction paid in a car lease is similar in concept to a down payment when you are purchasing a car and need a loan. Without this upfront payment, the monthly lease payments would be much higher. Here is a quick example of how that works:
Car Lease Payment Example
Let's say you looking to lease a car for 36 months that costs $25,000 and interest rates on car loans are around 7%. Let's also assume that the residual value of the car after 36 months is around $13,250. In this example, the lease payments will be equal to the car's depreciation of $11,750 ($25,000 - $13,250) plus loan interest on $25,000 at 7% for 36 months. This works out to around $438 / month. However, the lease looks much more attractive if there is a capitalized cost reduction of let's say $4,000. Now the monthly payments only have to be $315 / month.
When the leasing company calculates the residual value of the car this calculation is based on the total mileage the car will be driven over the course of the lease. So sticking with our example, if the residual value is $13,250, then the assumption might be that the 3 year old car would have around 36,000 miles on it (12,000 miles per year for 3 years).
If you've driven the car more miles, you will have to pay for the decrease in residual value. If a 3 year old car with 36,000 miles is worth $13,250, then a 3 year old car with 50,000 miles is worth less than $13,250 - and you will have to pay the difference. That fee is referred to as the excess mileage fee and the annual mileage limit is sometime referred to as the mileage cap.
If you're interested in seeing how these car lease calculations are performed, we've got a car lease spreadsheet that you can download for free. Later on in this article, we'll tell you where you can find some online calculators that can also help you run through some leasing scenarios.
Leasing Calculation Checklist
Finally, here is a checklist of questions you need to ask whenever leasing an automobile. The answers to these questions can help you to better understand exactly how much the car lease is costing you:
- What is the agreed-upon value of the vehicle?
- How much are the up-front payments, including the capitalized cost reduction?
- Are there any fees paid at the start of the lease?
- Does the lease require a security deposit?
- What is the length of the lease?
- What are the proposed monthly lease payments?
- Are there any fees at the end of the lease?
- What are the charges for excess miles?
- Is there a purchase option at the end of the lease?
- Does the lease include gap insurance coverage?
Automobile Lease Terms
If you've never leased a car before, all of the jargon and terminology can be confusing. The last thing you want to do is enter into a lease agreement and not completely understand the financial commitment you're making - so it's important to understand all of the terms and conditions on your lease contract.
We've got an entire article that contains over 30 of the most common terms you'll encounter when evaluating a car lease. You'll find all that information in our car lease glossary.
Online Car Lease Calculators
We stated earlier that we'd show you where you can find some online tools to help you run through some car lease calculations. We're going to finish up this article by letting you know where you can go to find those tools: right here in our online auto loan calculators! There you'll find an online version of our car lease calculator and even a tool that can help you decide if it's better to buy or lease a car.
About the Author - Automobile Lease
Bill Sharlow is the Editor of Money-Zine.com. Copyright © 2004 - 2007 Money-Zine.com
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