Car Leasing or playing with fire? 8 simple tips to keep your wallet protected!
In my opinion you get burned less playing with fire, but before you go out and strike a match, here are some very quick tips to control the flame at the dealer:
1. First and foremost know your total car cost! Even if you don’t understand a single thing about a lease, do yourself a quick check and multiply the payments by the term, add any incentives or rebates, add any down payment, and add the cost of the car at the end of the lease (residual value).
Payments *(term) + Incentives + Rebates + Down payment + Amount due at end of lease (Residual value) = Total cost of car.
Why is this important? Simple, you can compare this to doing traditional financing. In most cases, the lease of the car should cost close to financing the car. Lease factors and interest rates vary slightly, but it is still a good gauge. If they feed you lines that lease rates are not good because banks are only offering special interest rates, then maybe you should not lease. This is almost always not true, if the banks are running good interest rates they probably have good lease rates.
2. Come prepared with traditional financing costs! This is important for step 1. Calculate the cost of the car using interest rates from 1-6% and 36-60 months. If you don’t know how to do this search our site for loan amortization or download our free loan tool for MS excel. Simply calculate the payment for 1%,2%,3%,4%,5%,and 6% and in any incentives and rebates, and down payment.
Now you have something to compare. If the total cost of the lease in step 1 is close to the total cost of the car is step two at 5%, then you know your car if purchased at the end of the lease would be similar to buying the car at 5% interest. If the buy financing offered by the dealer is 0% for this loan period then you know you have work to do as the lease is a lot more expensive.
3. OK, so you compared total cost and they equal the appropriate interest rate, am I getting a good deal? This is where leases become confusing for the average consumer. The answer is probably not if you plan on turning in the car at the end of the period. Why? Leasing in other words is financing the depreciation of the car. We have all heard the expression “the car loses value the minute you drive it off the lot”. This is true, usually in the neighborhood of 20%, this loss in value is what you are paying for in a lease. So, if you pay more than the expected loss of the car of the term you choose you are not getting a good deal.
4. Don’t put a lot of money down! This is the single easiest way to set your wallet on fire. Remember in tip #3 that you are financing the estimated depreciation. If you put money down, the dealer can put the money towards the residual value of the car and give you a low payment. If you trade you car in at the end of the lease you just lost your down payment.
5. Ok what is the proper amount to put down? In my opinion nothing. It is a lease, however, we can’t always qualify for that so do a simple check. Calculate the following: payments*term + down payment + rebates and incentives. Look at that number and then ask yourself is this how much the car is going to loss value in over the term I am looking at? For example, if you do this math on a 30K car that you want to lease for 36 months and the value equals 20K, then something is wrong. Either you payment is to high, you down payment is to high, or they did not give you the rebates. Warning, when doing this compare keep in mind that you pay interest in the lease based on the lease factor so your numbers may be off a little depending on the lease factor they gave you. If you did step one and two, then you know you approximate equivalent interest rate and you should be able to determine a reasonable amount to factor in.
6. Leasing is financing the depreciation of the car! I know this has been said before, but it is so important to understand this. There is no need to have a residual value at the end of the lease that is below what you think the value of the car is going to be at the end of the term. Your payment should be the lowest you can get while keeping the residual value high or above the estimated value of the car at the end of the lease. This seems the opposite of what you would thing, right? Well, if your residual value is higher than the car is worth at the end of the lease, then you are in effect renting the car for less while you are driving it which is the object of a lease (very important: remember all you checks in step 1 and 2, it is you check that they have applied all amounts).
7. In most cars, 36-month leases are optimal. Why? It has to do with depreciation. Any longer and your paying for a steeper rate of decline and it does not make sense to do that.
8. Never do off – term loans (i.e. 39-months, 52-months, etc)! These are designed to build in better profit margins while looking better to the consumer. I have never seen one in that is better then a traditional term loan. They might be out there, but if you go down that path be sure you know how to fully calculate everything on the loan because if you don’t you are probably better off pulling all your cash out of your wallet, handing it to the dealer, and then leaving.
Before you lease always know at least how to do the tips above and please do more homework. Leases are very easy for dealers to make incentives and down payments disappear. I firmly believe, that with out leasing the car dealers would be in far worse condition profit wise today.
Be wise, do you homework and happy leasing! Send questions out to the public in the comments!
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