How Does Car Leasing Work?

Excited about getting a new car this year? Everyone loves driving a new car but the fact is new cars are expensive. If you haven’t leased a vehicle before or have been wary to lease, take a few minutes to learn how it works and you’ll see why leasing can be a win, win, win proposition for consumers, dealers and manufacturers.
Consumers win because paying for the portion of the vehicle they use means a lower monthly payment than if you pay for all of it. The bigger win for you is that you have no risk regarding the value of the car at lease end. Dealers are more likely to see your return for service and get a chance to lease or sell you another car at term’s end. Manufacturers know consumers who lease are more likely to remain loyal and lease another car.
Below are the key terms you’ll find in a new car lease.
Closed end lease:
A closed end lease calculates the residual value at the time of lease signing. You know the residual value and what your purchase price will be at lease end term. Don’t enter into an open ended lease, it gives the lessor too much control.
Lease agreement: A lease agreement is no more than a long-term rental contract. It details how much you will pay for the portion of the vehicle you plan to use based on term (months) and miles. It also contains requirements for insurance coverage, maintenance and license/registration. Lastly, your lease agreement details excess mileage penalties and excess wear and tear fees.
Vehicle Price:
You negotiate the sale price for a lease in the same manner as a purchase, If your price for a car with an MSRP of $30,000 is $28,500 (before incentives) you can lease it for the same price.
Lease Acquisition Fee:
This is a standard fee that ranges from $595 for most new cars to $995 for a Porsche. Most of this fee offsets the cost of guaranteed asset protection (GAP. GAP coverage protects you in the event of a total loss, paying the difference (or GAP) between your remaining obligation (payoff) and the amount your insurance company is willing to pay. (Example: $24,000 total remaining obligations – $20,000 from insurance company leaves $4,000 to be paid by GAP coverage.)
Capitalized Cost (Cap Cost):
The vehicle price + lease acquisition fee = Capitalized Cost
Sales price $28,500 + $595 Lease Acquisition Fee = $29,005 Capitalized Costs.
Incentives:
Incentives vary from purchase to lease, so be sure to verify all you are eligible to receive. Lease incentives include increased residual values, lower lease rates, customer cash and loyalty.
Trade Equity:
The amount the dealer is willing to pay for your trade-in less payoff due. $12,500 (2011 Chevy Equinox) – $8,500 (Ally) = $4,000 trade equity
Net Capitalized Cost (Net Cap Cost):
Cap Cost – Incentives – Trade Equity = Net Capital Cost
$29,005 Cap Cost – $1,500 Rebate – $4,000 Trade = $23,505 Net Cap Cost
Residual value:
The estimated value (%) of a new car’s MSRP the lessor (manufacturer finance company or bank) expects a new car to be worth the end of the lease term. If a lender estimates residual value to be 64% of MSRP at 36 months it means: MSRP $30,000 x 60% = $18,000 residual value.
Cap Cost Reduction:
Cash down used to reduce deprecation and monthly payment. Note, don’t put a large sum of cash down or prepay a lease. Your GAP coverage pays for your unpaid obligations. More cash down or prepaid leases mean you lose your cash.
Depreciation:
The portion of the vehicle you plan to use is referred to as depreciation. Net Capitalized Cost – Residual = Depreciation.
$23,505 – $18,000 = $5,505 depreciation
Lease Payment:
Monthly lease payment is comprised of 3 costs: monthly depreciation + lease rate + use tax.
Base Lease Payment:
Depreciation divided by lease term. $5,505 / 36 months = $152.9
Use tax:
States charge lessees a use tax the same % as sales tax. The majority of states calculate the use tax by multiplying base lease payment (monthly depreciation). Some though, charge use tax on the Sale Price the same as they do a purchase. Examples of both:
CA: $152.92 x 7.5% = $11.47 / month
GA: $28,500 x 7.5% = $2,137.50 or $59.38 / month
Bank or Lease Rate:
The % rate (sometimes referred to as a money factor) charged for the term of the lease. Lease rate: $24.32 / month
Total Monthly Lease Payment:
Base lease payment + use tax + Lease rate = total monthly payment
$152.92 + $11.47 + $24.32 = $178.71
Mileage Penalty:
The mileage penalty’s if you exceed your allotted mileage at lease end term range from $.25 to $.35. It is important to understand that if you pay for 45,000 miles over a 3-year term and return the vehicle with 40,000 miles, you receive no credit for surplus miles. The goal with a lease is to pay for those miles you are sure to drive so you don’t over pay.
For more information:
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