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home : AutoCenter : Financing :

Lease or Buy?

There are plenty of good reasons to lease a new car ... and there are plenty of equally good ones not to.

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Leasing has become increasingly popular over the last few years for several reasons:

  • By leasing, instead of buying, you get to drive a brand spankin' new car every two years or so.
  • Lower monthly payments and up-front costs (usually limited to a security deposit).
  • At the end of the lease, you can either buy the car, or just drop it off back at the dealership and forget about it.

How Does a Lease Work? Contrary to what you might think, you don't lease the car from the dealership, but from a leasing company that purchases the car from the dealer you're negotiating with. After the terms of the lease are worked out through said dealer, the leasing company rents the car to you, with the dealer taking a cut and profiting from the sale of the vehicle.

Your payments are determined by the difference between the "capitalized cost" (the price for which the dealer sells the car to the leasing company, which is negotiable) and the car's "residual value" (the projected value of the car at the end of the lease -- not negotiable, but maintainable, provided you take good care of the car). If the car is sold to the leasing company for $20,000, and is expected to depreciate 35% in value by the time the lease expires, you'll pay the remaining 65%, plus an interest rate known as the "money factor," which is set beforehand by the leasing company.

There are two types of leases available. In the first, a "closed-end lease," the residual value of the car is fixed at the start of the lease. In the second, an "open-ended lease," the residual value is estimated at the start of the lease, and then compared to the market value upon termination. You pay the difference if the market value falls below the residual value. You should only consider a closed-end lease.

At the end of the lease you're given the offer to buy the car for the remaining 35%. If you choose not to, you can just walk away, provided you didn't damage the car or exceed the maximum mileage -- either can be quite costly.

Other options to consider include buying the car and selling it privately for a profit, or "trading it in" to the dealer for a credit towards another lease or purchase.

Why not?

You're aware of the advantages of leasing: lower payments, less financial responsibility, a freshly minted ride every few years -- but there are also a number of disadvantages that need to be weighed before jumping in.

  • Many leasing companies impose mileage restrictions on leased vehicles, mainly as a measure for ensuring the integrity of the residual value. This number is often 15,000 miles. If the limit is exceeded, you'll be charged rather heftily by the mile. Leases are not ideal for traveling salesmen or anyone else spending lots of time on the road.
  • It generally costs more to insure a leased vehicle.
  • If you go through with the lease and then buy the car for its residual value, you will have paid significantly more than you would have had you bought the car in the first place, partially due to interest rates on used cars being significantly higher than those on new ones.
  • If you decide to lease, you may end up paying the dealership for doing absolutely nothing. Among these are "disposition fees," which you may be expected to pay when you drop the car off, and "acquisition fees," for which you'll be milked for picking the car up. Both are somewhat bogus, and can run upwards of several hundred dollars. It will behoove you to find a dealer who doesn't include such charges, or is willing to drop them.
  • A leased car doesn't belong to you, so you'll pay thousands without ever being able to proudly consider it "yours." Also, you can't modify/customize it without paying dearly upon the termination of the lease.
  • If you terminate the lease prematurely, prepared to be screwed. Consider this: If the car was expected to depreciate by 30% in three years, and you want out after the first year, in which the value of the car already dropped 20%, then you likely haven't paid anywhere near the current depreciation (the steepest decrease in value comes right after you drive the car off the lot, then slows over the next few years). You'll have to pay the difference, known as the "gap." There may are also be stiff penalties for early termination.

All in all, it's important that you fully understand what you're getting into before deciding if a lease is right for you. A little healthy foresight can prove invaluable in the long run.

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