How to Lease a Car
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Are you thinking about leasing a car for the first time, but don’t know how to lease a car? Don’t worry…
One thing to remember when you ask how to lease a car:
Leasing is a negotiable sales transaction; just as is a car purchase. These days, most car leases are closed-end leases. If you are sure that you will drive the car within your agreed upon mileage (usually between 10,000 and 12,000 miles per year), the risks in leasing are no different than buying a car with a loan. And, knowing how to lease a car is no harder than knowing how to buy a car. The goal is simple: Get the car you want at the lowest possibly monthly payment, with little or nothing down. In a nutshell, that’s how to lease a car! There are several financial factors that go into calculating a lease payment, but really, there are only three things that you will need to learn in order to know how tolease a car:
Terms on How to Lease a Car
- Sales Price
When you lease a car, you negotiate a sales price, just as if you were to purchase it. In other words, it is up to you to negotiate the best deal you can. To know how to lease a car starts with knowing the price of the car, just as if you were buying it. For example, if a 2010 Subaru Legacy has a MSRP (Manufacturers Suggested Retail Price) of $23,000, but the Dealer Invoice price is $21,300, your settled price will fall somewhere in between these two amounts. Obviously, getting the best discount you can will result in a lower monthly lease payment, just as if you were to buy the car on a loan. So, know the MSRP and the Dealer Invoice of the car – vital parts in learning how to lease a car at the best monthly payment.
- Interest Rate
The other common factor between determining monthly Car Lease payments and Car Loan payments is the interest rate. Obviously, the lower the interest rate, the lower the monthly payment. When you buy or lease a car, the dealer stands to make as much or more money from the financing part of the deal as the profit on the sales price of the car, itself. The dealer knows how to lease a car so it’s up to you to know a little bet about how they do it. Monthly payment is a big negotiating factor, whether we are leasing or buying a car on loan. Even though Car Lease calculations are based on a term called, Money Factor, it is basically no different than an interest rate. The Money Factor is calculated by taking the interest rate and dividing it by 2400. For example, the money factor on a car lease figured at 7% is, .0029 (7 / 2400). The Interest Rate or Money Factor is somewhat negotiable based on your credit score. Knowing how to lease a car is not dependent on knowing the money factor. Just understand that it is based on an interest rate and will greatly affect your payment, just as it does when calculating any loan payment.
- Residual Value
If there is one factor which differentiates a car purchase from a car lease, it is the resale value, or ‘residual’ value of the car. The residual value is what the car’s projected value will be after your lease term has expired. On a 3 to 4-year car lease you can expect the car’s resale value to be worth 50-70% of its original MSRP. Cars with higher resale values are typically much better cars to lease because you are paying for less depreciation. This is why Japanese car makers like Honda and Toyota are able to offer attractive low monthly lease offers, while American cars with lower resale values have recently abandoned car leasing altogether. For a long period of time, American car companies were using rebates and discounts to bring attractive car lease offers to consumers, despite the fact the residual values of their cars were 15-20% lower than their Japanese and German competitors. Over time, too many leased American cars were being turned back in well below the estimated value, meaning the banks and dealers were losing money putting them back on their lots and trying to resell them. With the recent crisis in the finance industries, banks no longer wanted to take on risks for greatly depreciated cars, making it nearly impossible for American Car dealers to offer competitive monthly lease payments. So, if you are considering leasing a car, you will probably have to confine your choices to Honda, Nissan, Subaru, Volkswagen, Toyota, Mazda, etc. If you have your heart set on a Chevy Malibu, Cadillac, Dodge Challenger, Ford Mustang, etc., consider buying one that is one to two years old at a greatly reduced price. If you know how to buy a car, you know how to lease a car.
How To Lease a Car: Calculating a Car Lease Payment
A lease calculation is based on a two part formula: Depreciation + Interest. When we lease cars, we only have to pay for the portion of the car that we use. This used portion of the car is called, depreciation. The attractive idea behind this is that we are not putting money into an asset at a rate that is faster than which it depreciates. Residual values are determined by a third party source as a percentage of the suggested retail price of the car. . To determine the depreciation portion of your car lease payment, you will need to know four things about the car: The MSRP, the Capitalized Cost, the Lease Term (# monthly payments), and the car’s Residual Value. The Capitalized Cost is simply your agreed upon sales price less any down payments you make. Knowing how to negotiate the sales price is the same as knowing how to lease a car.
Let’s say, you negotiate a 36 month lease on a Subaru Legacy with an MSRP of $23,000, and a residual value of 65%. . The car’s residual value after three years is $14,950 or ($23,000 * .65). If you negotiate $1,000 off the price of the car, your agreed upon sales price is $22,000. In this example, we are putting no money down, so the Capitalized Cost is equal to our agreed-up sales price of $22,000. The depreciation amount is simply the difference between the Capitalized Cost ($22,000) and the residual value ($14,950) So, the total monthly depreciation payment will be $7,050 divided by 36, which is $195.83. Note, that by not negotiating the $1,000 discount, our payments would be $28.00 higher. ($1,000 / 36 – $28.00) So, getting a great discount on the price of a car can greatly reduce your payment. The second part of the lease payment formula is based on an interest rate which is known as the, Money Factor. The Money Factor is determined by bank, but can be made available to you simply by asking the dealer. For purpose of our example, the money factor is .0029. To determine your Interest Portion of the payment, you add the MSRP and Residual Value together and multiply the resulting number by the Money Factor. Hint: The money factor is derived from the interest rate divided by 2400. (7% / 2400= .0029) So, the money factor in our example is based on a 7% interest rate. Now, let’s determine the interest portion of our monthly lease payment.
Interest Payment= (MSRP + Residual Value) * Money Factor. Or as stated in our example: ($23,000 + $14,950) * .0029 = $110.00
Now that we know both parts of the payment, we add the two together to get our complete monthly payment: $195.83 + $107.16 = $302.99
There is one part of the payment we have not considered: Sales Tax. The Sales Tax is usually figured into the monthly payment and will be roughly equivalent to whatever your local taxes are. For my own purposes, a $302.99 lease payment, would probably men an additional $22.00 per month based on a 7% sales tax.
Don’t be intimidated by this complex, tw0-part lease calculation. While it is nice to know, it is not at all necessary to get a great deal on a car lease. If you would like an easier way to calculate a lease payment, you could also use a Car Lease Calculator, like this one: iLeaseMyCar Pro for iPhone What is more important than understanding how to calculate a lease formula is how to negotiate the best deal.
Negotiating a Car Lease
It may be more difficult to negotiate a discount on cars with strong resale values, but that doesn’t mean we shouldn’t try. There is simply no reason to ever lease a car for full MSRP. There is always a competitor somewhere in town that is willing to make us a better offer. We simply have to ask for it. This may seem obvious, but never lease a car for a monthly payment that is anywhere close to the same as what it would cost you to buy it. (Seems, hard to believe, but I know people who have) Dealers can take advantage of the less informed and make huge profits by driving up the interest rate and/or selling the car at full MSRP. So, first and foremost, let the dealer know that you are informed about the basic elements of leasing and that you are prepared to negotiate the resale price and monthly car payment. Simply asking the dealer for the residual value, money factor or interest rate will go a long way in preventing them from giving you a raw deal. Let them know you are informed and prepared to negotiate a fair deal.
Comparing a Car Purchase to a Lease
So, armed with the knowledge of a car’s MSRP, Discount Price, Interest Rate and Residual Value, we should have a rough idea of what kind of cost and monthly outlay we are willing to pay on a car lease. Obviously, it may not always be easy, convenient or possible to calculate a lease payment right on the spot. What you can do, however, is compare the loan payment on an actual car purchase. A good car lease should generally yield a payment that is 30 – 35% cheaper than a 60-month purchase loan payment. It would be quite easy to calculate a monthly payment on a $23,000 car discounted down to $22,000 at 7% interest on a 60 month loan. Using a simple loan calculator (or if you have an iPhone, with iLeaseMyCarPro), you could quickly determine that such a car would cost you $455.00 per month to buy on a 60-month loan. Over 5 years, the total cost to own the car would be $27,300. This is before taxes, of course. It wouldn’t make sense to lease the car unless the payment and total costs over three years were substantially less than this. Knowing that I could buy the car for $435.00 a month with no money down, I would be reasonably happy to lease the car for $300 a month on a 3 –year term. $300 per month over 3 years adds up to a total cost of $10,800 as opposed to $27,300 over the five year purchase period. I would be happy to make that deal on a car I really liked. Furthermore, just because I set my monthly payment goal at $300.00 doesn’t mean that would be my starting point with the dealer. I would tell him I wanted to lease the car for $225.00 a month, knowing full well that he would come back with a figure of about $300 and expect me to counter his counter-offer. Always, begin your negotiations with a demand that is lower than what you are actually willing to pay. Realize that the dealer is doing the very same thing. Residual values, money factors, sales discounts; all serve as tools that the dealer can use to get you in the car at the payment you want. So, while it is advantageous to make the dealer aware of your knowledge, it is not absolutely necessary to use all of these facts and figures in order to negotiate the best deal. Let the dealer do the work to get the price down. Also, there are many other variables you can bring to the bargaining table in order to keep things in your favor.
Other Car Leasing Tips
- Leasing Term
In our example, we used a 36 month lease. There are also 24, 48 and 60 month leases as well as anything in between. You can find the relative strengths and weaknesses of car lease terms here: Car Lease Term Considerations. The Car Lease term, can be a negotiating factor in getting your lease payment down, or helping you make a decision. It may be advantageous to lease a car for longer than the average 36-month term if it drastically reduces your monthly payment.
- Cap Reductions
You can also use what is called a Cap Reduction; or down payment, to further reduce your payment. Personally, I don’t like to do this. The reason to lease cars is to preserve monthly cash flow. Keep in mind, that any discount you pay up front really just goes into your Average Monthly Cost to acquire the car for the lease period.
- Security Deposits
Many leases, particularly luxury cars like BMW and Mercedes require a security deposit. This is a fee you pay up front; usually equal to the amount of a monthly payment, which is refunded to you upon returning the leased car. Think of it as a damage deposit on a rental. Security deposits can often be negotiated and even if it can’t, use it as a red herring at the bargaining table. The more demands you make up front, the more the leverage you maintain in negotiating the important financing considerations of the lease.
Nearly all car leases allow 10,000 – 12,000 miles per year. Anything above that, usually results in an extra fee of .10 – .25 per mile. If you drive over 12,000 miles a year, you may not want to lease; and if you drive over 15,000 miles a year, you definitely will not get a very favorable lease deal. Start with 12,000 miles, even if you are certain you will only drive the car 10,000 or less.
- Excess Wear and Tear and Disposition Fees
I’ve never been charged with excess wear and tear on any car that I’ve ever leased. The usual dings and dents are allowed, as well as reasonable tire wear for the term of the lease. However, just recently I was charged a $400 Disposition or Termination fee upon turning in my 2008 Hyundai Veracruz a few months ago. I should have known better than to agree to this. I figured at the time, that I would be trading the car in for something new. Financial considerations and circumstances do change, so it is important to recognize this ahead of time. After all, one of the reasons we lease cars is to minimize our risks and capital costs. Don’t agree to any additional costs, but use them as leverage so the dealer has to make concessions to reach a favorable deal.
- Ask for an Upgrade
In some cases, you may reach the point where it becomes obvious that the dealer has done everything they can to accommodate your demands, but just can’t reach your desired monthly payment. It is possible they might be able to offer you a better car for the same money. You might say to them, for example, “I won’t pay $299 a month for the SE Version of the car, but I would be willing to pay $289 for the Limited Edition with leather seats.” Because of the way residual values affect your monthly payment, sometimes the more expensive car with a better resale value actually yields a better monthly payment. I experienced this first-hand when I leased my 2008 Hyundai Veracruz. I was trying to obtain the smaller, cheaper Santa Fe for $299.00 a month. When they couldn’t come within $30 of making the deal, I decided, just for kicks, to ask about the Hyundai Veracruz. As luck would have it, I learned that Hyundai was offering a brand new lease special on the 2008 Veracruz. So, I was able to lease a bigger, better SUV for only $10 more.
Use Your Number One Car Leasing Resource
Okay, maybe I’m a little too proud, but I do think this website has lots to offer a prospective car buyer or leaser. Use MonthlyCarLease.com and my Car Lease Ratings Guide as a resource and benchmark for comparing Lease Offers. My monthly car lease articles are intended to provide some historical perspective as well as a guide to comparing offers and lease specials on many different models and makes of cars. Knowing how to lease a car depends on knowing the good deals. Refer to the Monthly Car Lease Archives to compare your own LVR (Lease Value Ratio) against the Top-10. The LVR is simply your Average Monthly Payment divided by MSRP. The lower the number, the better. In a nutshell, one can know how to lease a car, simply by using the LVR Ratings here on Monthly Car Lease. That’s the way way and that is all you need to know How to Lease a Car.
Filed under: Car Leasing
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