Car Leasing 101

Who can resist the ads? Lease the car of your dreams for a mere $199.00 and very little down. It doesn’t take much to see why leasing has become a popular option for those who either can’t afford to buy a new car, or can’t afford to upgrade to the model they really want. But most folks don’t end up knowing if their lease deals are good or bad, and they typically can’t explain what they’re paying for or how their payments were calculated. Many find the process confusing, even intimidating, because the lease language has its own oddball jargon, like capitalized cost, residual value and money factor.

If you can’t understand what they’re saying to you, you can’t understand what they’re doing to you. So let’s first understand how Car Leasing works. You, the lessee, agree to make specified monthly payments in return for driving car a specified number of miles over an agreed-upon time period — typically two or three years.
The leasing entity is the lessor — a financial company that buys the car from a dealership and leases it to you. Today the lessor is usually the automaker’s captive finance company. The transaction is handled by the dealership, acting as a middleman between you and the car company.At lease-end, you return the car to the lessor through a dealership for that brand, and you’re back to square one. It’s not a “trade-in” because it’s not your car.
The monthly payments will always be lower for leasing than for buying. But leasing can be a great choice, a so-so choice or a terrible choice, depending on your financial situation and how you feel about spending your money.

Leasing makes the most sense for people who answer “yes” to one or more of these questions:

  • Do you need to minimize your monthly car payments?
  • Do you typically get a new vehicle every three to four years?
  • Do you own a business that’ll make those payments? (Your accountant may advise you to lease.)
  • Do you drive 15,000 miles a year or less?
  • Do you always want to be covered by the initial bumper-to-bumper warranty?
  • Do you want an extended “trial period” before committing to buy?

Buying makes the most sense for those who answer “yes” to one of more of these:

  • Do you typically keep your cars for 5 years or more?
  • Do you want to get the maximum value for every transportation dollar you spend?
  • Do you drive significantly more than 15,000 miles a year?
  • Can you afford to pay off your car loan in 5 years or less?

Leasing is a good option for many people, but it will never be the most cost-effective way to get around. If you lease forever, you’ll be making car payments forever. And you’ll always be paying for the highest depreciation years. The way to get the most value for every new-vehicle dollar you spend is to buy a reliable car, pay it off, then drive it several more years. Making an expensive repair periodically is usually a lot cheaper than buying two or more new cars over the same period.

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