Getting a Good Deal on Your Next Vehicle: How Vehicle Leasing Works
Let’s face it: if you’re like most of us, you probably think leasing a vehicle is more confusing than buying one. Most leasing terminology, after all, is born out of commercial equipment financing. This article aims to set the record straight, helping you navigate the leasing process so you can feel more confident the next time you visit a dealership and explore this opportunity.
Vehicle leasing basics
When you lease a vehicle, you don’t own it. The lender (the financial entity you make payments to) instead buys the vehicle from the dealer and essentially “rents” it to you. In doing so, you pay the cost of depreciation (the dollar value your vehicle will lose over the leasing period) plus interest, fees, and taxes minus any rebates.
As the largest component of your lease payment, depreciation is calculated as the difference between the vehicle’s price you negotiate down from the MSRP and its residual value (what the dealer expects the vehicle to be worth at the end of the lease).
The higher the residual value (implying the vehicle is well-equipped to hold its value), the lower the payment. It’s this very concept that explains why you can sometimes lease a more expensive vehicle for a lower monthly payment than you would have negotiated for a less pricey brand.
Depreciation triggers
Every vehicle is different, and some makes and models depreciate more quickly than others; vehicles that are in high demand and historically very reliable suffer the least depreciation and thus make for excellent leases. Feel free to visit websites such as Kellybluebook.com and/or Edmunds.com to familiarize yourself with vehicles that boast the highest resale values. Mileage also influences residual value; the less you drive (lower mileage allowance), the lower the monthly payment on your next lease.
How to negotiate your next car lease
Leasing means you can negotiate the vehicle’s purchase price but can’t change the residual value the lender uses to price your lease. Therefore, for haggling purposes, avoid alerting the dealer that you firmly plan to lease until after nailing down the final cost. The lower you negotiate the purchase price of the vehicle, the lower your monthly lease payment.
How vehicle lease interest rates work
Known as “the money factor,” leasing interest rates are expressed a little bit differently than they are for car loans and reflect an estimate of your monthly interest payment typically written as a decimal (e.g., .00275). The estimate you receive is based on your credit score.
To ensure you’re receiving a fair deal, you’ll first need to convert your money factor into an annual percentage rate (APR): simply multiplying the money factor by 2,400.
For example, if your money factor is 0.0020, your APR is 4.8%. Once calculated, this number should mimic national new car loan interest rates. If your rate is significantly higher, you can either negotiate your money factor down or walk away. This is important; the lower your money factor, the lower your monthly lease payments and total finance charges.
Additional lease fees to consider
As for taxes and fees, know you’ll be charged an acquisition fee to initiate the lease (though you can sometimes roll this into your monthly payments). You’re also responsible for the same fees you’d pay to buy the vehicle—including title, license, and registration fees—and can roll these into monthly payments as well.
It's also critical to understand some extra charges potentially on the table. Examples include penalties for exceeding your allowable mileage and disposition fees that compensate the lender for cleaning/reselling the vehicle after the leasing period ends.
Some states also require paying sales tax up front, either on the full price of the vehicle or the capitalized cost (cap cost) of your lease—with the latter reflecting the total amount of money you finance with your agreement, including the vehicle’s negotiated price and any fees or taxes you haven’t yet paid. Keep in mind, however, that dealerships do offer rebates to help reduce leasing costs.
Reasons to avoid putting money down on your next car lease
Unlike when you purchase a vehicle, most experts advise against putting money down on a lease: because if the vehicle is stolen or totaled, GAP insurance (which your lease should include) will ensure the lender is reimbursed but not refund your down payment. Consequently, you could be out thousands of dollars!
Putting additional money down won’t affect your interest rate either, as the money factor is based solely on your credit score.
Decisions to make before your lease is up
Before you begin daydreaming about your next vehicle, you’ll need to make a few important decisions—some of which can save you money.
First and foremost, decide next steps for your current vehicle at least 90 days before your leasing period ends—revisiting your lease agreement and reviewing the residual or buyout value if you decide to keep it. You can use Edmunds’ appraisal tool or Kelly Blue Book’s value estimator to determine what the vehicle is worth and then inquire to learn if the buyout price is negotiable.
You’ll also need to assess the number of miles you've driven, staying local and/or avoiding driving the vehicle altogether if it looks like you’ll go over your mileage limit.
You can also check the manufacturer’s website for “lease pull-ahead programs,” deals that allow you to end your current lease and initiate a new one from the same manufacturer. To strike a deal, the dealer may forgive any excess mileage and damage to help make sure you don’t walk away.
If your vehicle requires any repairs, you’ll want to either tackle these yourself or head to your local repair shop—which can help you avoid getting hammered by exorbitant dealer fees. This is especially true if you aren’t planning on leasing or buying your next vehicle from the same manufacturer.
The bottom line on leasing your next car
While the vehicle leasing process is often more confusing than buying, it thankfully doesn’t take an advanced accounting degree to learn the associated vocabulary and score a great deal on your next leased vehicle. Perhaps it’s time to give it a go!
Questions about leasing your next vehicle? Schedule a FREE Discovery call with one of our CFP® professionals.
FAQs
-
Unless you live in one of five states that doesn’t charge sales taxes on cars (Alaska, Delaware, Montana, New Hampshire, or Oregon) or a state that doesn’t offer tax credit for trade-ins (California, Hawaii, or Virginia), a trade-in will reduce the amount of sales tax you pay on your car (note that Michigan caps tax credits at $10,000). That’s because only the net amount (amount of your new vehicle minus your trade-in value) is subject to sales tax. If you decide to sell your used car either on your own or elsewhere, you’ll be liable for sales tax on the entire amount.
-
Yes, you can lease a used car (and potentially save lots of money in the process!), provided your dealership offers this option as not all do.
-
Buying a new car is almost always less expensive in the long run, giving you an asset (albeit a depreciating one) to sell when it’s time to purchase a subsequent vehicle.
The decision to buy or lease, however, ultimately boils down to your own personal circumstances. For example, if you want to spend as little as possible on a car, buying is often the way to go. Those who prefer to change cars every few years and thus enjoy the latest model, security, and technology features, meanwhile, are a good match for leasing.
—— —
Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.
Disclosures:
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
