Automobile Lease

The decision to own or lease an automobile is as much about a lifestyle choice as it is a financial option.  Whenever making a major investment decision, as is the case when buying a car, it's important to weigh the pros and cons of buying versus leasing the vehicle.

Leasing a car is a popular choice in America today.  There are many people that like the idea of driving around in a new automobile.  Leasing is also a good option for individuals just starting out in the working world, since committing to a large down payment on a purchase may be financially undesirable.

Leasing an Automobile

In this series of articles, we are going to cover the more important points that can help you decide if leasing a car is the right decision.  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 one of the easier concepts:  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.  That is to say, after all of your monthly car loan payments have been made, and the car is owned outright.

When you buy a car, you will typically have to pay upfront 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 payment of a capitalized cost reduction in a car lease is similar in concept to a down payment when you are purchasing a car.  Without this upfront deposit, 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're looking to lease a car for 36 months, at a cost of $25,000, and the interest rates on car loans are 7%.  Let's also assume the residual value of the car after 36 months is $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 per month.  However, the lease looks much more attractive if there is a capitalized cost reduction of $4,000.  In this example, the monthly payments are now only $315 per 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.  Sticking with the example above, if the residual value is $13,250 then the assumption would be the three year old car would have around 36,000 miles at lease end (12,000 miles per year for three years).

If you've driven the car more than the allowed miles, then you will have to pay for the decrease in the car's residual value.  If a three year old car with 36,000 miles is worth $13,250, then a three 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 have a car lease spreadsheet that you can download for free.  Later on in this article, we'll tell you where you can find online calculators that can also help you run through some leasing scenarios too.

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 upfront 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, then 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 on the car.  It's important to understand all of the terms and conditions on your lease contract.

We have an entire article dedicated to this topic; one that contains over 30 of the most common terms you'll encounter when evaluating a car lease.  You'll find all of 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 car lease calculations.  Those tools appear in the online auto loan calculators section of this website.  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 - 2011 Money-Zine.com