A car-leasing primer

Low monthly payments are tempting, but before you head to the showroom, read this.

By Dennis Murray
Senior Editor

A car is a depreciating asset—a money pit, to put it bluntly. To keep a car on the road, you'll spend thousands of dollars a year on fuel, routine maintenance, repairs, insurance, and registration fees. The object of the game is to keep your costs as low as possible for as long as you own the vehicle.

So . . . should you lease your next car, to lower your monthly payments?

The answer isn't the same for everyone. If you'll hold onto a vehicle for more than four years or put more than 15,000 miles a year on it, you ought to buy. That will cost less over the long haul, especially if you pay cash or get interest-free financing for the term of the loan (see "How the leasing formula works").

Several other factors also enter into the lease-vs-buy equation. If you lease and later find that you have to terminate the contract early, you'll face stiff penalties that could easily wipe out any savings you might have enjoyed from lower payments. Some leasing companies (or manufacturers, if they lease cars directly) may let you out of your contract by charging you a few hundred dollars to "assign" the balance to another lessee. But you'll have to ask about that possibility before signing the contract. If the company you're dealing with doesn't allow it, you'll have to try an independent firm that handles swaps, such as LeaseTrader (www.leasetrader.com) and Swapalease ( www.swapalease.com).

Moreover, if you're hard on your cars—you haul a lot of kids, pets, or building supplies—think twice about leasing. At the end of the lease, you'll be charged extra to repair any damage that's beyond what's considered normal wear and tear. This also argues for keeping a lease short—three years or less—so that it coincides with the term of the manufacturer's bumper-to-bumper warranty.

But if you treat your vehicles well and get the itch for a new car every two or three years, then leasing might be the way to go. Your up-front costs will be nominal, and your monthly payments will be lower than they would if you'd purchased the vehicle. At the end of the lease, you can simply turn in the car without the hassles of having to sell it or trade it in, or you can buy it.

Those are nice perks for you, but don't encourage your 20-year-old college student to lease a car. "There's little doubt that he or she is going to bring a bunch of friends in the car, and the wear and tear will be excessive," says Art Spinella, president of CNW Marketing/Research in Bandon, OR. "That's a chance you really don't want to take."

If you've decided that leasing is the way to go, read on. Leasing involves its own set of jargon and guidelines; we'll walk you through them to help you get the best deal.

Welcome to Leasing 101

With a lease, you're essentially paying for depreciation. Your total payments represent the difference of what the car's worth today (the "capitalized cost" or "cap cost") and what it's expected to be worth at the end of the lease (the "residual value"), plus taxes and a finance charge (the "money factor"). The smaller the gap between the capitalized cost and the residual value, the lower your monthly payment.

Do you have room to negotiate? Definitely—even if a salesperson tells you otherwise. Your goal is to arrive at a cap cost that's below the vehicle's sticker price (the MSRP, or manufacturer's suggested retail price). So go into the negotiations ready to bargain, just as you would if you were purchasing the vehicle.

First, find out how much the dealership paid for the automobile, based on the invoice price and any holdbacks it may have received from the manufacturer. Holdbacks are rebates that can increase a dealer's profit margin. You can get this information from popular guides such as Edmunds ( www.edmunds.com) and Kelley Blue Book (www.kbb.com ). Then ask the dealer or leasing company whether any rebates or other manufacturer's incentives for consumers apply to the capitalized cost. If you have a car that you'd rather trade in than sell privately, you can also use its value to reduce the cap cost.

Next, you'll need to firm up the second part of the lease equation—the vehicle's residual value, which is often expressed as a percentage of the MSRP. "The best cars to lease are those whose 24-month residuals are at least 50 percent of their original suggested retail price," says Albert D. Hearn, a leasing consultant in Marietta, GA, and editor of LeaseGuide.com ( www.leaseguide.com), an online resource that can help you calculate your lease payments. "Remember, higher residuals lead to lower lease payments."

The final part of the equation, the money factor, may be more difficult or impossible to negotiate if your credit rating is anything less than spotless. But money factors are coming down, Art Spinella says, as leasing companies realize they have to compete with cash rebates and low-interest financing deals.

To convert the money factor into an annual percentage rate (APR), multiply it by 2,400. For instance, a money factor of 0.0025 is equivalent to 6 percent. "The result should be comparable to, if not lower than, local new-car loan rates," Hearn says.

After the numbers, consider the terms

Let's assume that you're satisfied with the cap cost, the residual value, and the money factor, and together they've given you an acceptable monthly lease amount. (To see how the math works, look at the example below.) Next you'll be asked to choose either a closed-end lease or an open-end one.

Most people take the closed-end lease, commonly known as a "walk away," because it allows you to simply return the car at the end of the term and have no other obligations. If the car's residual value is lower than the amount stated on your contract, the dealer must eat the difference. If it's higher, you may want to buy the car and flip it for a quick profit.

With an open-end lease, you, not the leasing company, assume all of the risk. If the vehicle's actual value winds up being less than the estimate, you're responsible for paying the difference. Because of this, open-end leases are usually a little cheaper than closed-end ones. But the trade-off is rarely worth it. You could be on the hook for thousands of dollars if a hot model cools off by the time the lease is up. Moreover, today's cut-rate financing deals will likely lower used-car values. So resist the temptation to save a few bucks each month; take the closed-end lease.

If the dealer offers you "gap insurance," take that, too. It's important, because if the car is totaled or stolen, your insurer might not cover all of what you still owe on the lease. Gap insurance pays the difference between the straight-line depreciation that's represented in your monthly lease payments and the actual depreciation, which occurs much more rapidly in the early part of the lease. Some lease contracts include gap insurance automatically; others charge a few bucks a month for it.

In addition, pay attention to the annual mileage limit specified in your contract. Exceed it and you'll pay extra for each additional mile. If you think that's likely to happen but you still want to lease, negotiate the price of those anticipated extra miles before you sign. If the leasing company normally charges, say, 15 cents a mile, see if you can get that down to 10 or 12 cents by purchasing miles up front. Your contract should state that you'll get a refund for any unused prepaid miles.

Under the federal Consumer Leasing Act, you have a right to full disclosure of the costs and terms of a lease. To view a sample contract, go to www.pueblo.gsa.gov/cic_text/cars/key2leas/forms.pdf .

Can't stand haggling? Turn to the Internet

You might think you need to be a real wheeler-dealer to get a good deal on a lease. Not true. In fact, several reliable services will handle the negotiations for you.

For $335, LeaseWise (www.leasewise.com) will search its database of 40 possible lease plans and get at least five dealers to bid on your business, based on the make and model of the car, lease term, and anticipated yearly mileage. LeaseWise then verifies the terms of each lease plan and confirms all of the numbers with the dealers before sending you a full report. Once you decide which dealer to use, you call the manager directly and make the final arrangements.

A less expensive alternative is LeaseWizard ( www.leasewizard.com ). For $34.95, you'll receive quotes from six banks and financing companies for the make and model you choose. You're responsible, though, for following up with the lenders and reviewing the contract. LeaseCompare.com (www.leasecompare.com ), which leasing expert Al Hearn recommends, provides a similar service, but first you must negotiate the cap cost for the vehicle and give LeaseCompare.com the figure. You'll also pay a $49 application fee to lock in the money factor, but that fee will be deducted from the amount due at lease signing.

Bottom line: Lease if you like the thought of lower monthly payments and a new car every few years. Purchase the vehicle if you're good to your cars and keep them for many years, which lowers your overall costs.

A no-interest loan or a lease?

Buying never gives you lower monthly payments than leasing does—not even with interest-free financing. However, in the long run, buying saves you the most, if you pay cash for the car. And an interest-free loan is the equivalent of cash, if—and this is the key—you'll pay no interest for the entire term of the loan. Such deals do exist: GM's financing arm, called BuyPower, recently gave qualified buyers interest-free loans for up to 60 months if they purchased any 2003 Buick, Cadillac, Chevrolet, GMC, Oldsmobile, Pontiac, Saab, or Saturn.

Interest-free financing is actually better than a cash deal in that it gives you the added bonus of spreading your total payments over several years. If you pay cash up front, you no longer have that money available to invest or to use to pay down a mortgage or other loans.

Even doctors who previously leased are finding the lure of low- or no-interest loans and fat rebates hard to resist. Just ask internist Bruce A. Goodman, of Wrightstown, PA. In March, his local Buick dealer offered him the choice of interest-free financing or a $3,000 cash rebate on a Rendezvous. He purchased the SUV through his practice and took the cash, a deal he says was "just too good to pass up."

In fact, nearly two-thirds of people who buy take the rebate over no-interest financing, for a couple of reasons: The money can serve as a down payment, and in turn lower the overall amount financed. That doesn't mean, though, that a rebate is cheaper in the long run. "Ask what the payment would be with and without no-interest financing, over the same time period," suggests Art Spinella, president of CNW Marketing/Research in Bandon, OR. "If the difference is equal to or greater than the rebate amount, it's better to take the loan."

How the leasing formula works

Let's assume you've decided to lease a four-cylinder Toyota Camry XLE over three years. The sticker price with options is $24,600, but you've managed to negotiate that down to $23,000. The dealer shaves off $5,000 more for your trade-in, leaving you with a net capitalized cost of $18,000.

Next, you ask about the money factor and learn that it's 0.00275. That works out to 6.6 percent (0.00275 x 2,400). After 36 months, the Camry's residual value is 60 percent of the MSRP, which equals $14,760.

Here's how you'd figure the lease payment (excluding sales tax):

Dennis Murray. A car-leasing primer.

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