Car Handbook

Get a Lease on Leasing

With all the newspaper and TV ads devoted to auto leasing lately, you’d think leasing was a brand-new concept. It’s not. What’s new is that manufacturers and dealers are promoting leasing more than ever before. And it’s working. Increasing numbers of people who drive new cars are leasing instead of buying.

Why is leasing so popular? Is it a fad? Are people simply being influenced by well-produced ads? Or has leasing become as good a deal as buying—or even better? There’s no easy answer. That’s partly because leasing terms and calculations are complicated and partly because comparing buying to leasing is like comparing apples to oranges. Which one is better depends upon individual finances, circumstances, and desires. We’ll try to help you sort these out for yourself, so you can judge if leasing makes sense for you.

What Is Leasing and Why Is It So Popular?

Leasing is basically long-term car rental, usually lasting two to four years. You agree to pay a leasing company a fixed amount each month to drive the car, which the leasing company owns, and you also pay for insurance and routine maintenance such as oil changes. You receive a warranty, as you would for a car you’d buy. And, as with a car you own, if you damage a leased vehicle, you and your insurance must cover repairs.

It’s important to note that, unlike buying a car, leasing may mean that you will always have monthly payments. When you buy a car, the car loan is typically paid off long before the car is worn out. In contrast, leasing usually means endless payments. Although you may be able to buy the car at the end of the lease, most people who lease turn in the car at the end of the term and lease another. So the payments continue. In the long run, leasing may be more costly than buying, despite the lower monthly payments.

Then, you may wonder, why is leasing so popular? There are several reasons. With the prices of cars climbing, it has become harder and harder to afford monthly payments that will pay off a car in three years or less. And with new cars costing more than $20,000 today, loans are being stretched over four to six years. By the time you truly own a car, it may not be worth a whole lot in the marketplace. It still may be worth a lot to you, however, if it gets you where you’re going and allows you to drive a car without making payments. That’s something to keep in mind as you learn more about leasing.

Leasing is also popular with people who don’t like driving older vehicles. They can always drive a new car needing relatively little maintenance and fewer repairs than most older cars. If you lease a new car every couple of years, you can always drive a fairly new car. Although you will never escape monthly payments, the payments will be lower than they would be if you were buying a new car every two years. This is the main attraction to leasing a car.

Who Typically Leases?

Leasing is a decision based on personal choice, as well as personal finances. For some people, leasing is a good idea for many reasons. For others, it’s like a spin on a race track: It offers a short-term thrill, but doesn’t get them anywhere in the long run. See whether or not you resemble one of the following drivers.

The Drive for Success

If you’re like Becky Gilbert, image is extremely important to your success. And if, like Becky, you’re just starting your career, you might not yet be able to afford to buy the car that gives your clients the confidence that you’re a “winner.” By leasing, Becky has decided she can impress her clients by taking them out to lunch in a smooth-handling, mid-sized car with ample passenger room. And she can make the monthly payments required without straining her finances.

The Family That Stays Together

Steve and Julie Smith are in their late 30s and have three young children. They want a car roomy enough to comfortably fit the family and a few friends as well as various toys, bikes, and camping gear for their summer vacations in Minnesota’s scenic parks.

The Smiths are trying to make ends meet on a limited income, yet they want a car that’s safe, preferably with built-in child seats and both driver and passenger air bags. They fear having to pull off the road with a carload of kids, so they also want a car with a low probability for mechanical failure.

Their wants and needs add up to a new minivan that they can’t possibly afford to buy. Recently, they decided to lease a new safety-equipped minivan when the dealer told them about the low monthly lease payments they could make. For once, they didn’t bat an eye at the price.

Living the Good Life

Bob Jacobson has never been one to save. His income is steady, but it doesn’t afford him the lifestyle he wants. He was turned down for a loan to buy the four-wheel-drive truck he wanted. When he found out he could lease the same truck for less each month, he nearly jumped at the chance, but he didn’t feel right about it. By the time the lease was up, he reasoned he’d still have to finance the truck in order to own it. Or, he’d have to keep making payments to lease another truck and possibly come up with another down payment, too.

Bob decided to buy a less expensive car rather than leasing the truck he could not afford to buy. After four years of making loan payments he can afford, he’s guaranteed he’ll own a car and then have a few years of payment-free driving in which to save money for the truck he really wants.

The Pride of Ownership

Jim Merriman made the final payment on his hatchback three years ago. His wife ribs him about driving a “beater,” but in truth the car’s body has held up well. Jim also has tuned up the engine on schedule and replaced a few parts. All in all, the money Jim saves by not having monthly payments makes him gleefully happy every time he sits on the sun-bleached seats.

He’s even started a bank account to put away the money he’d be paying every month if he were leasing. It’s growing so big he plans to use some of his savings to fly his family to Florida in the dead of winter, and he’ll still have a sizable down payment left when he wants to buy a new car.

Why Are Monthly Payments Lower When You Lease?

The monthly payments may be lower when you lease a car than when you buy it because you’re mainly paying for the car’s depreciation. Depreciation is the value the car loses over the time you drive it. If a car is worth $18,000 new, and you lease it for three years, during which time it depreciates by $7,000, you pay $7,000 to lease the car (plus interest and other fees listed on your leasing contract).

If you were to buy the car, your monthly payments would have to be higher to pay off the full price of the car. Loan payments to buy a car are often spread over four to six years to bring the monthly cost down. Still, the monthly payments may not be as low as they would be if you were leasing.

Is Leasing a Good Deal?

Does the fact that you’re making lower monthly payments when you lease mean you’re getting a better financial deal than if you’d bought the car? No—to properly evaluate the deal, you need to look at the long-term financial outcome and all the terms of the lease.

Beyond Monthly Payments

Even though leasing ads often emphasize low monthly payments, it is critical to look beyond the monthly payment to understand the total cost of a lease. Examine the up-front and back-end fees included in the lease. And, if you don’t mind doing a little math, learn how the monthly fee is tabulated to ensure you’re getting a good deal. Sometimes the low payments that sounded so good in an ad can conceal hidden costs that add up to a poor deal. Check your lease for these important disclosures:

1. The Car’s Price
Make sure the price of the car is listed on the lease. This figure, also called “capitalized cost,” is similar to the sale price you would pay if you were buying the car. It is important to know the capitalized cost because it will determine how much you will have to pay each month.

2. The Trade-in Value
If you’re trading in a car, make sure the amount you’re receiving for the car is shown on the lease. It should be listed separately and subtracted from the car’s price (capitalized cost), if you have “positive trade equity.”

If you have “negative trade equity,” then you owe more on your loan than you will receive in credit for the trade-in. In this case, the amount you still owe, minus the amount the dealer is giving you for your trade-in, will be added to the capitalized cost and will increase your monthly payment. The dealer will then pay off the balance on the loan for the car you trade in.

3. Other Price Reductions
Make sure any manufacturer’s rebate you were promised, any down payment you’re making, and any discount you negotiated for the car are listed on the lease and subtracted from the car’s price. Again, if they’re not specifically listed and subtracted, you may not be getting as low a payment as you should.

Trade-Ins and Outs

The value of your trade-in vehicle should be shown on your lease separately from the price (capitalized cost) of the car you are leasing.

Negative Equity
Do you owe money on a loan for your trade-in vehicle? If so, you may have “negative trade equity.” You have negative equity if you owe more on your loan than the dealer is giving you in credit for your trade-in.

$13,000.00 Balance owed on loan before trade-in
- 10,000.00 Trade-in credit from dealer
$3,000.00Total “negative trade equity”

By trading in your old vehicle, you won’t receive a discount on your leased car, but you will reduce the amount you owe on your loan. In this example, the $3,000 in negative equity will be added to the capitalized cost of the car you lease. The dealer will then pay off the outstanding loan on the trade-in.

Positive Equity
If you have no payments left to make, or still have a few payments to make on your car but the dealer will pay you more to buy your used vehicle than you owe, you have “positive trade equity.” In such a case, the positive trade equity should be applied in one of the following ways:

  1. Subtracted from the capitalized cost, and shown as such on the lease;
  2. Subtracted from the up-front payments you’re making to lease the new car;
  3. Given to you in cash; or
  4. Some combination of these.
$10,000.00 Trade-in credit from dealer
- 7,000.00 Balance owed on loan before trade-in
$3,000.00Total credit toward your leased car, or "positive trade equity"

With the trade-in, you can pay off your loan and also get a discount toward your lease. Be sure the positive trade equity is shown on your lease contract—and is applied to reduce the capitalized cost.

Get the Credit You Deserve
See that the amount of your positive trade equity is subtracted from the current price (capitalized cost) of your new leased car. If the trade equity isn’t subtracted from the capitalized cost, you may not be receiving the credit you are entitled to!

When you trade in a car, double check that the contract shows the correct price (capitalized cost) of the car you’re leasing. If it’s higher than you expected, don’t hesitate to point this out to your dealer and get the price you had negotiated.

Tip: Consider selling your vehicle yourself rather than trading it in. That way you know exactly what you’re getting for it—and you may get more than a dealer will give you.

Bumper-to-Bumper Fees

The Front End
Remember that the cost of a lease includes more than just the monthly payments. For starters, it includes the up-front payments. One of these, the security deposit, is usually refunded at the end of the lease (unless there is damage to the vehicle). Others, like a down payment, aren’t refunded. You will probably have to pay an acquisition fee of $400 - $900 to take out a lease.

Before you get too excited about monthly payments of $200 on a 24-month lease, for example, check to see whether you will have to make a significant down payment. If the down payment is $2,400, that’s the equivalent of paying another $100 each month you’ll be driving the car.

The Back End
Fees tacked on when you turn in the vehicle at the end of the lease can add a big chunk of money to your leasing bill. Know your driving habits before you lease, so you’ll be able to predict these back-end fees.

Charges that generally add the most to the cost of leasing are extra mileage and excess wear and tear, but there are others to watch for, such as a termination fee for ending the lease early. You will also probably pay a disposition fee of $300 or so, at the end of the lease.

Finally, be sure you understand the details of the lease. Insist that the dealer walk you through it slowly. Don’t be fast-talked into a deal you don’t fully comprehend. Dealers currently aren’t required to tell you all the elements they use to arrive at the monthly fee, but a customer-friendly dealer will.

If you feel pressured to sign a contract or are unsure of what you’re signing, walk away. A good deal should still be available if you decide to return to the dealership to buy or lease a car. So take your time. Remember, there’s no three-day cooling-off period! Once you sign the lease, you must abide by its terms.

Who’s Who in Leasing?

Who are the players in the leasing game? While your dealer makes all the arrangements to lease you a car, the dealer is a liaison between you and the leasing company that owns the car. You make your payments to the leasing company, not to the dealer.

Leasing vs. Buying: When Ownership Is the Goal

It’s not always easy to figure out if you’d be better off leasing or buying from the start if you ultimately want to own the car. Even so, it’s a good idea to try to determine which makes the best financial sense for you.

To figure out what you’d pay for a car at the end of the lease, ask for the “purchase option price,” or the amount you’d pay to buy your leased car at the end of the lease. Then, add in monthly interest for financing the purchase after the lease is up. While the purchase option price may be negotiable, it’s what dealers plan to charge based on the estimated value of the car at the end of the lease.

Now compare leasing to financing. First, how much of a down payment could you make to lower your monthly payments if you buy the car? When you decide the size of the loan you’d need to buy the car, check loan interest rates offered by your banks or credit union, as well as those offered by your dealer, to make sure you’re comparing leasing with the best financing deal you can get.

Take a Second Look
What are your reasons for considering leasing? Did you fall in love with extra accelerating power, smooth handling, or a leather interior and “moon roof” on a car you can’t afford to buy? If so, rethink your decision to lease. You may be better off buying a less expensive car now and saving your money to buy the car you really want later.

How to Get a Good Deal

You can get a good leasing deal by taking a few simple steps:

Turning Over Your Engine

Many people who lease like the fact that the length of a lease is usually short, allowing them to frequently turn in one car for another. But if you lease, plan to keep the car for the entire length of the lease or you’ll most likely pay a substantial penalty for breaking the lease.

Because the formulas for calculating these penalties are complex, ask your dealer to give you a detailed example using real numbers. Ask specific questions, such as: “What will the penalty be if I end the lease next January?”

What if I Want Out?

There is no three-day cooling-off period when you lease, just as there isn’t when you buy a car. So carefully consider what you’re signing when you sign a lease, because you’re promising to make lease payments for the full term of the lease.

Buying the Car at the End of the Lease

When the lease period is over, you can usually opt to buy the car. To decide if buying makes good financial sense, revisit the purchase option price discussed above. How does it compare with the price for a similar used car?

Sometimes the purchase option price is actually less than you’d pay to buy a similar car from a used car dealer. If that’s the case, consider yourself lucky.

Trucks, for example, were unexpectedly popular in the early ’90s, and many people leasing them were able to buy them at the end of their leases for a much lower price than the same truck bought from a used car dealer.

If your car holds its value better than was anticipated when you signed the lease, it’s obviously smart to buy the leased vehicle for the purchase option price. If you don’t really want to own the vehicle, but don’t mind a little work, you can sell it immediately and pocket a profit. On the other hand, if the purchase option price is higher than the market value of the car, buying it is not a sound financial option. If you want to buy the car anyway, you may be able to negotiate with your dealer to lower the price. But if the dealer won’t match the market price, walk away.

Leasing Glossary

Leasing terminology is confusing and intimidating. To add to the confusion, not everyone uses the same terminology. Take the following glossary with you when you shop for a lease so you have the meanings of all the terms right at your fingertips.

Acquisition Fee, or Assignment Fee: An additional fee charged by the leasing company. This fee usually ranges from $400 to $900 and is often included in the monthly payment. Sometimes, however, you are required to pay the fee up front.

Adjusted Capitalized Cost, or Net Capitalized Cost: The “capitalized cost” (car’s price), minus any deductions to reduce the price of the car. Common deductions are the down payment, trade-in credit, and manufacturer’s rebate. The adjusted capitalized cost is used to calculate your monthly payment. It is similar to the “amount financed” in a purchase transaction.

Capitalized Cost: Equivalent to the price of the car, including any tax and add-ons, extra warranties, insurance, rustproofing, or other options that you’ve agreed to pay for.

Capitalized Cost Reduction: Anything that reduces the capitalized cost before the monthly payment is calculated. It usually includes your cash down payment, trade-in credit, and manufacturer’s rebate.

Depreciation: The value that a car is projected to lose over the period of time you drive it. It’s the difference between the adjusted capitalized cost and the residual value.

Disposition Fee: A charge by the leasing company to take the car back and fix it up for sale after the lease is up. Not all leasing companies charge this.

Down Payment: An amount you pay up front to lower your monthly payment. It should be subtracted from the car’s capitalized cost, or price, before the monthly payment is calculated.

Early Termination Fee: A penalty payment that may be added to the amount you owe if you terminate your lease early. This could amount to several thousand dollars.

Excess Mileage: Most leases allow for a maximum number of miles per year. Any miles driven over the limit are usually billed at between 10 and 25 cents a mile.

Excess Wear and Tear: Damage done to the car beyond the expected wear and tear from driving. Excess wear and tear is usually determined by the leasing company.

Gap Insurance: If your leased car is stolen or totaled, your insurance will pay for the damage or loss. It won’t help you make payments still owed to the leasing company. Gap insurance makes up the shortfall, or gap, between the value of your car and the amount you still owe on your lease, including a possible penalty for early termination of the lease.

Gross Capitalized Cost: This is the capitalized cost for the leased car, plus the amount of any “negative trade equity” that is added to the capitalized cost.

MSRP: Manufacturer’s Suggested Retail Price, or “sticker price.”

Money Factor: A number that leasing companies use to arrive at the interest charge for your monthly payment. Unfortunately, the number looks nothing like an interest percentage. It will be something like “.00375.” For many leases, the general rule is that 2,400 multiplied by the money factor is the interest rate. Working this equation out, we see that a money factor of .00375 gives us about a nine percent interest rate. However, not all lease companies use the same conversion factor to convert the money factor to an interest rate.

Monthly Payment: The monthly lease payments made over the term of the lease. Generally, it includes your depreciation, interest, and taxes.

Net Trade-In Allowance: This is the amount of credit the dealer is giving you for your trade-in, after taking into consideration the loan balance on your trade-in. Depending upon the amount of your loan, you will have either “positive trade equity” or “negative trade equity.”

Purchase Option Price: What you’ll pay for the car if you buy it at the end of the lease. The purchase option price is often tied to the residual value. If it is, then the higher the residual value, the more you’ll pay to buy the car, should you decide to do so, at the end of the lease period.

Rent Charge: In a lease, this is basically the total amount of interest you are paying. It is also known as the “lease charge.”

Residual Value: How much leasing companies have estimated that the car will be worth after your lease is up. The residual value affects the amount of your monthly payment. Dealers have books with charts estimating the residual value, which is usually shown as a percentage of the sticker price (MSRP), and determined when the car is new. The higher the residual value, the less you will pay each month to lease your car. (See also “depreciation.”)

Security Deposit: Usually the same amount as one month’s payment paid up front. You’ll get it back if the car is in good condition at the end of the lease.

Zero Down: When the only up-front fees you will have to pay are the tax and license fees. Thus, if a dealer offers a “zero down” lease, you should not have to pay any fees up front, such as a security deposit or down payment.

What the Leasing Company Must Tell You

Federal regulations require leasing companies to disclose certain information to consumers about the terms and costs of their lease. The information that must be disclosed includes:

Required Disclosures

  1. The amount of any up-front payments (down payment, security deposit, and first month’s payment).
  2. The number, amount, and due dates of your monthly payments.
  3. The total amount of your monthly payments over the course of the entire lease.
  4. The cost of the license, registration, and taxes.
  5. The gross capitalized cost for the leased car.
  6. The net trade-in allowance you are receiving for the car you trade in.
  7. Any capitalized cost reduction.
  8. The adjusted capitalized cost.
  9. Rebates and non-cash credits.
  10. The residual value.
  11. A description of the insurance provided or required under the lease.
  12. The warranty terms.
  13. Who is required to take care of the car and pay for maintenance.
  14. The standards for determining wear and tear (if the leasing company sets such standards).
  15. Penalties for default or late payments.
  16. Whether or not you can buy the car at the end of the lease and at what price (purchase option price).

One lease term that leasing companies are not required to disclose is the money factor. However, if you decide that you want to do your own lease calculations or check the leasing company’s calculations, you will need to know the money factor applied by the leasing company. If you want the information and the leasing company will not give it to you, consider taking your business elsewhere.

Raise Your Leasing IQ

The Nitty Gritty of Lease Calculations

Before you sign the contract, go over it with a fine-toothed comb—or better yet—a calculator. Checking the numbers is a little complicated but well worth the trouble. Everyone makes mistakes sometimes, and you’ll pay, literally, for any wrong calculations used to figure your lease.

See the “Leasing Glossary” for help in understanding the terms used in the following section. In this section, first you’ll learn how to calculate a monthly payment, then you can fill in your own calculations. You’ll also want to review the lease to make sure you understand the up-front and back-end fees, as well as any other terms that you agree to when you sign the lease.

Check Your Monthly Fee

The following formula will allow you to calculate your monthly payment within a few dollars of the actual payment. All you need is a pen, paper, and probably a standard calculator, unless you like to do your math by hand.

Warning: These calculations will work for most leases. However, some lease companies may use a different type of money factor and a different formula for calculating the monthly payment.

Figure Your Lease Payment

Determine and fill in the following numbers in the spaces below:

Example:Your Lease Payment:
MSRP (sticker price)$22,000
Capitalized cost$20,000
Net trade-in allowance$2,000
Adjusted capitalized cost$18,000
Residual value$11,800
Term of lease36 months
Money factor.00335

In this example, the sticker price (MSRP) was $22,000, but the customer was able to negotiate a lower leasing price (“capitalized cost”) of $20,000. In addition, the trade-in credit reduced the capitalized cost by another $2,000 to $18,000. (Make sure that your trade-in credit and any other discounts are included in the calculations arriving at the adjusted capitalized cost.)

The monthly lease payment is made up of two parts: the depreciation charge and the monthly interest, or lease charge. It is calculated as follows:

Monthly Depreciation
The total depreciation charge is calculated by subtracting the dollar amount of the residual value from the adjusted capitalized cost and then dividing by the number of months in the lease. This is a measure of how much the car’s value is going down each month.

(Adjusted Capitalized Cost - Residual Value) / Months in Lease = Monthly Depreciation
Example: ($18,000 - $11,800) / 36 = $172.22

Monthly Interest Charge
This is what the leasing company charges you for using its money. It is sometimes referred to as the “rent charge” or “lease charge.” The monthly interest charge is calculated by first adding the adjusted capitalized cost and the residual value. Then multiply the result by the money factor.

(Adjusted Capitalized Cost + Residual Value) x Money Factor = Monthly Interest Charge
Example: ($18,000 + $11,800) x .00335 = $99.83

Total Monthly Lease Payment
The total monthly lease payment equals the monthly depreciation plus the monthly interest charge. (If you want to know approximately what the interest rate on your lease is, in most cases you can multiply the “money factor” by 2400. This conversion works for most money factors, although some lease companies may use a different conversion factor.)

Monthly Depreciation + Interest Charge = Monthly Payment
Example: $172.22 + $99.83 = $272.05


There you have it: your monthly payment. The calculation should be within a few dollars of the amount the dealer quoted. If it’s not, insist that the dealer go over all the costs in the monthly payment. Are there any hidden costs? If the dealer can’t explain all the costs to your satisfaction, walk away.

Note: Another way to calculate your monthly payment is to follow the steps on a business calculator with a lease program. If you do this, you will probably need to convert the money factor to an interest rate before you do the calculations. As a reminder, the usual way to obtain the interest rate is to multiply the money factor by 2400.

Final Questions

Before you sign your lease, you should review it and ask yourself the following questions:

Leasing Form

A sample leasing form prepared by the Federal Reserve Board is available here. Dealers may use a form very similar to this.