If you’ve read my articles for any length of time, you may have noticed I’ve leaned toward the frugal side of spending for well, most of my life. Recently though I’ve learned to loosen up and allow myself some wants as well as needs, and to spend a little extra for things that add beauty and enjoyment to life rather than be strictly utilitarian (my mother’s dream finally came true when I understood that it was okay to own more than 3 pairs of shoes, and they don’t even need to be practical). So along those lines I did something wild and crazy that I never would have done just a few years ago- I traded in my not yet beat into the ground, not even yet paid off, three year old car for a brand new one. In my defense, I had some practical reasons for doing so, but I also did something else I thought I’d never do- I leased it.
Since in the past my strategy has been to keep my cars until they were on life support and only then grudgingly buy the next one, a lease hadn’t been the smart way to go. But this time around my needs were a bit different and the lease deal presented to me by Major Hyundai for the new Kona I was eyeing made great sense. So how do you know if a lease is a good deal for you? Before we dive into the details of that, let me just say that typically when I shop for a car I go with my defenses up, expecting to be hard sold on a monthly payment and having to press for the relevant numbers like the actual price of the car or the trade in. This was not the case with Major Hyundai. It was an easy and pleasant experience. My salesman was low pressure, forthright with the details, and came up with several good ideas about how to structure the deal and helped me think through what would be best. And I absolutely love my Kona. It’s my most favorite car yet (sorry baby Cobalt).
Many people lease because they like to drive a newer car- whether for safety features, reliability or simply enjoyment- and they can get more car for their money than they would with a loan payment. At face value, a car lease is a monthly car rental payment. More specifically, the payment is the cost of financing the difference between the sales price of the car and its residual value — the price you would pay to purchase the car at the end of the lease. So it follows that the lower the sales price, the less you’ll need to finance. Even though the focus is usually on the monthly payment, the actual price of the car does matter so negotiate as you would if you were purchasing the car outright. Once you have agreed on a sales price for the car, the dealer will sell it to the leasing company for that price, and the leasing company will finance the car for you.
For argument’s sake, let’s say my new fictitious car has a sale price of $25,000.
The sale price of the car plus any fees (like title and registration, document fees, and the biggie, the acquisition fee) is the gross capitalized cost. Rebates, net trade in, and any down payment are considered a capitalized cost reduction and subtracted from the gross capitalized cost to get the adjusted capitalized cost, and that is used to calculate your base monthly payment.
In our example, after fees my gross capitalized cost is $25,900 and I’ll be bringing $5,900 between net trade and rebates to the deal; my adjusted capitalized cost is now $20,000.
The next number to look at is the residual value, which is the agreed upon value at the end of the lease term. If you plan to lease the car and turn it in at the end, the higher the residual value the better because your payments will be lower. The residual value should be at the very least 50% of the price of the car. In some cases, when an auto manufacturer wants to promote a particular vehicle, it may “subvent” the lease by offering a higher residual value or a higher rebate on the price of the car.
My fictitious car has a residual value of $13,000. The first part of a lease payment is the depreciation fee, or the difference between the adjusted capitalized cost ($20,000) and the residual value ($13,000). We take the difference, $7,000, and divide it over the term of the lease, in this case 36 months, to get $194. The 36 months duration is a popular lease term, because the car is still covered under the manufacturer’s warranty during the term and less likely to need major repairs. In essence you are paying for the decline in value over the lease term.
The second part of a lease payment is the finance cost or rent charge. That figure is determined by a “money factor” which is not the same as an interest rate, but can be used to calculate the rate. The money factor is applied to the total of the adjusted capitalized cost and the residual value (in this example $20,000 plus $13,000 to get $33,000). If the dealer doesn’t provide the money factor you can back into it. Here I took the “Rent Charge” of $2,628 specified on the contract, divided it by 36 months to get a $73 finance charge per month, then dividing that $73 a month by $33,000 for a money factor of .0022. But what does that money factor represent? If you multiply it by 2,400 (regardless of the length of the lease), you’ll get the interest rate you are paying; in this case, 5.28 percent.
Now we have a monthly payment of $267, but that is exclusive of sales tax. In Pennsylvania, the sales tax on a car lease is 9 percent, so we need to add $24, for a total payment of $291. While the sales tax rate is higher on a lease than the 6 percent on a purchase, a benefit is that you are only paying tax on the portion of the car’s price that you are using, versus paying tax on the entire sales price.
What about making a bigger down payment to lower the monthly payment? Not quite the same benefit as
putting more money down on a car you’ll finance to own. While it does lower the payment- putting down another $3,600 in this example would lower the payment to $174, saving $117 a month- there is a risk of losing that down payment if the car is totaled early on in the lease. Insurance payments are made to the leasing company and after paying them off there may or may not be any money left to refund to you- if your contract even allows for that. On the flip side, if you owe more than the car is worth, you could be on the hook for the difference unless you have GAP insurance (guaranteed auto protection insurance). GAP insurance fills in any gap between the insurance settlement and your responsibility, and is often included in a lease as it is with Hyundai. But if it’s not, best to look into getting it on your own.
Finally, know your options at lease end; what fees are involved with turning the car in or buying it, and how much you will pay for any miles over the allowance.
Under the right circumstances, leasing a car makes good sense- just know that the financial process is different from a purchase and understand what you are agreeing to.
And if you do stop into Major Hyundai be sure to ask for Erik.
When you use your car for business, does leasing give you a bigger tax writeoff than owning your car? Read more here.