Car Leasing

Car Leasing is a subject that we use to supplement our car buying topic.  That's because the same individuals that are thinking about buying a car are often wondering if leasing a car is a better choice.  In this article, we are going to discuss what goes into the calculation of car leasing payments.  If you're thinking about getting a new car, this article might help you make a more informed decision.

Lease or Buy a Car?

We have discussed at length a process you can use to help choose the right car to suit your needs in our article Automobile Purchase.  When you have gone through that process, you will be faced with one final decision:  Lease or buy?

The popularity of car leasing has risen dramatically in recent years.  There is a constant flow of commercials on television, and on the radio, talking about inexpensive monthly car lease payments.  While automobile dealerships might be celebrating the success of this approach, as a consumer, you need to make sure you are making an informed decision.

Understanding Car Lease Payments

To understand how a dealership might calculate their car lease payments, you need to think about a car as an asset.  Like many other assets, a car's value goes down over time as the useful life of the car gets shorter.  In other words, the car is subject to depreciation in value over time.

Everyone recognizes that a used car with 100,000 miles on the engine is worth less than it was when first purchased.  The market value of the car has gone down.  The wear and tear that a car undergoes as it is driven simply lowers the market value of the car.  Unfortunately, the total number of miles a vehicle can be driven is considered finite or limited.

Calculating Lease Payments

When a car dealership structures a car lease, they are using historical data to project the market value of the car at the end of the lease.  For example, let's look at a car that is worth $25,000 when new and its value after a three year lease has expired.  The car dealership has a very good idea what a car of a given make and model is worth when it is three years old and has been driven nearly 36,000 miles.  For a car in that condition, let's assume the market value is roughly $10,000.

Car Lease Example

In this example, the capitalized cost of the car is $25,000 and its residual value is $10,000.  This means the leasing payments need to cover the $15,000 decline in value of the car over the lease term, plus interest expense and leasing fees.

One way that companies are able to provide lessees with low monthly lease payments is through a mechanism that is referred to as capitalized cost reduction.  Essentially, this is an upfront payment that "prepays" some decline in the car's value.  It's very similar to the concept of what happens when you have a car loan and make a down payment.

Going back to our example, let's assume the lease requires a capitalized cost reduction payment of $5,000.  This means you will need to make a $5,000 payment at the beginning of the lease.  It also means that the monthly car lease payments only have to cover the $15,000 decline in the car's value, minus the $5,000 paid up front, which is equal to $10,000.

Car leases typically include other upfront fees and security deposits.  The money you're borrowing on the lease is also subject to an interest expense, which is known as the money factor.

Mileage Charges

Mileage is also worth a quick mention in this example.  We assumed the car would have 36,000 miles on it when returned to the leasing company.  This assumption was based on a limit, or mileage cap, of 12,000 miles each year.  The mileage on a car has a lot to do with its value, so leasing companies set an annual limit on mileage.

If the car has more than the mileage limit when returned to the leasing company, you will likely have to pay a mileage charge to compensate the dealership for the car's lower value.

Car Lease Calculators

If you'd like to see all of these factors at work, then you should read through our article on car lease calculators.  There you'll find a detailed explanation of how a monthly car lease is calculated, along with a lease spreadsheet that you can download for free.

Online Car Lease Calculators

If you're looking for an online tool that you can use to run through some car lease payment scenarios, then you might want to take a look at our auto loan calculator section.  There you'll find a wide variety of car loan and lease tools including an online car lease calculator.

Car Leasing Tips

This is a good place to stop because now we know exactly how leasing companies calculate lease payments, and we know where to find tools to help perform these calculations.

We're going to finish up this article with a couple of car leasing tips:

• Always negotiate the lowest possible price on a car, because this is the same as the capitalized costs, which is used to calculate the monthly lease payment.  The lower the capitalized cost, the lower the monthly payment.  A good car lease will offer a capitalized cost that is less than the Manufacturer's Suggested Retail Price or MSRP.
• The best cars to lease are those that hold their value well.  If the residual value on the car is high after the lease is over, then the monthly payments can be lower.  This is the rationale behind the belief that leasing luxury cars is a good deal.  Luxury cars tend to be well-built automobiles, which have higher residual values.
• Don't judge a car lease offer just by the monthly payment.  Take a careful look at all of the costs associated with the lease, in particular a capitalized cost reduction payment.
• If you drive a lot of miles each year, then you need to pay special attention to the mileage charge associated with the lease.  These additional payments can add considerably to the effective monthly cost of the lease.

About the Author - Car Leasing

Copyright © 2005 - 2011 Money-Zine.com