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What is leasing?
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Leasing is a finance option that, depending on your financial situation, may make perfect sense. It could also be a big mistake.
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Leasing defined
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A lease is a contract that enables you to drive a car with financing that avoids the higher down payment and monthly payments associated with purchasing a new car.
Why lease?
In some ways, leasing is like renting. You are paying for the use of someone else’s car or truck. However, unlike renting, where you can bring back the vehicle earlier than necessary, a lease contract contains provisions to protect the finance company against early termination. If you lease, you’ll probably pay a heavy penalty if you break the lease by returning the car early.
The up-side to leasing.
If done right, leasing can get you more of a car for your money. It can be an alternate way to conserve cash, provide an easier way to shop and allow you to drive a more expensive car for a lower monthly payment.
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The down-side.
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If you approach leasing in a hurry, or without doing your homework, you could literally be throwing away thousands of dollars.
Unfortunately, most people approach leasing the wrong way. They usually go to the dealership planning to buy a car and decide on the leasing option because it seems a cheaper alternative to owning, without fully considering the long-term impacts.
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How does leasing work?
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The leasing company (the lessor) is usually the manufacturer, who buys the vehicle back from the dealership and effectively rents it to you. The lessor does not make a profit on the vehicle, but rather charges you a monthly sum based on the interest rate and their money factor.
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What makes leasing seem cheap?
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The lease payments seem cheaper than purchase payments for the same car, but in reality leasing isn’t always cheaper.
If you look at the total investment over the term of the lease, and compare it with the costs of buying, the number will be very similar.
The lease payment is “lower” because you only pay for the time you lease the car, and consequently receive credit for the end-value of the car, depending on how it depreciates. When you buy the car, you pay for the cost of ownership up front, but don’t have to worry about end of lease terms, such as going over your mileage and buy back costs.
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Two lease possibilities.
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There are two different types of leases to choose from, the closed-end lease and the open-end lease.
With a closed-end lease you are not responsible for the value of the car at the end of the lease beyond a specific amount. That amount is always defined based on the vehicle’s residual value.
The open-end lease is the type of lease you generally may want to avoid. This lease stipulates you may have virtually unlimited liability when you turn in the vehicle.
Figuring out if the car has good residuals?
The general rule of thumb is if the car you’re considering is popular now, it will be popular at the end of your lease.
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Negotiate terms of the lease.
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Just because the lease payment is lower doesn’t mean your cost is lower, or that you are necessarily getting a better deal than if you were to purchase the car.
If you decide to lease, two factors play an important role. First, be aware it’s possible to negotiate the terms of the lease (such as mileage allowed, number of months and the price of the car), and second, leasing contracts do not disclose all the facts you need in order to compare leases. For example, it’s important to know what will happens if you go over the mileage allotted at the end of the lease or the buy-back costs in case you decide to purchase the car at the end of the lease. Having this information is vital and gives you a balanced approach to comparing leases.
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Some leasing terms you need to know.
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The leasing company is called the lessor; the person doing the leasing is the lessee.
Acquisition fee is the sum of money you agree to pay the leasing company to arrange financing on a vehicle. It’s what the leasing company charges to “acquire” the lease. Not all leasing companies charge an acquisition fee.
Capitalized cost is the total selling cost of the vehicle that includes items such as taxes, title, license fees, acquisition fee and any optional insurance and warranties.
Cost of money tells you if the effective interest rate you are paying is right for the lease. This cost may also be called: a monthly lease charge, service fee, or service charge. Most leases don’t list this cost as an effective interest rate, they list it as a monthly amount. This makes it harder for a person to compare the cost of money from lease to lease, or compare the cost of money on a lease with a regular “purchase” contract. (Leases don’t clearly list the interest rate because the Federal Reserve doesn’t require them to.)
Residual value is the amount of money the leasing company says your leased vehicle will be worth when your lease ends. This figure is important for two reasons; the leasing company uses it to help determine your monthly payment and it is also used to determine the amount of penalties if you break the lease early.
This amount is determined based on the projected resale value of the vehicle at the end of the lease. It is basically a long-term guess.
Many leases should show you the residual value of the vehicle at the end of the lease. But, very few will tell you the residual value if you terminate the lease early. (Most leases use complex formulas rather than list value at a particular month.)
Insurance and warranty requirements may vary form one leasing company to another. It’s worth investigating beforehand.
Excessive wear and use is a fee charged by all leasing companies for any wear and use they consider beyond normal. The definitions of acceptable wear and tear will vary from lease company to lease company, as will the amount of the fees charged.
Security deposit is an up front amount that is refundable under certain conditions.
Disposition charge is a fee that leasing companies may charge when the car is returned. Not all leasing companies charge this fee and the amount will vary.
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