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Pro's and Con's of Leasing
Is Leasing Right for Me?
As with anything in life, there are a long list of pros and cons with
automotive leasing that should be fully understood and carefully considered
before you sign on the dotted line. Here are a few of the most important ones.
Advantages of Leasing
Lower Payments
With a lease your monthly payments will almost always be lower than a
conventional loan because you are paying for only a portion of the car's full
value over the lease period. This gives you the option of driving a nicer car
for the same monthly cost.
Manufacturer Incentives
In tough times manufacturers may offer very attractive terms such as
below market interest rates and artificially high residuals that both have the
effect of lowering the monthly payment.
Lower Up-front Costs
Unless you decide to make a large cap reduction payment, initial costs
for most leases will be limited to a refundable security deposit (typically one
monthly payment rounded up to the nearest $25), sales tax depending on your
state, title and registration fees, environmental fees (i.e., battery and tire
disposal fees), and finally, your first monthly payment. As a result, leasing
ties up less of your capital, freeing cash up for more lucrative investments.
Federal Taxes
With the tax reform act of 1989 phasing out deductions for interest on
car loans, leasing may now compare more favorably against conventional financing
from a tax standpoint. Although most individuals will not save taxes with a
lease, some businesses may enjoy certain advantages with leasing. Consult your
tax advisor for more information.
Sales Tax
Most states tax leases by taxing the monthly payment stream and any
cash down payment (cap reduction). This works out to quite a bit less than
paying sales tax on the full price of the vehicle as required in a purchase.
Hassle-free Disposition
At the end of the lease you simply turn the car back in to the dealer
and walk away. You won't have the effort and expense of selling the car or
haggling over its trade-in value. If you decide to buy the car at the end of the
lease you know about how much it will cost (no more than the residual value).
Disadvantages of Leasing
Early Termination
The terms for early termination of most leases can be very unpleasant
for the consumer, particularly if the termination is forced, i.e., the car is
totaled in an accident or stolen. In such cases, insurance pay-outs often fall
far short of the balance due on the lease leaving you holding the bag. Many
leasing companies will offer "gap insurance" for only a few dollars a
month extra which is a wise investment.
There is a very good reason why it is so
expensive to get out of a lease. Consider that your monthly payment is made up
of two parts: depreciation and interest. The depreciation part of the payment is
calculated by taking the difference between the cap cost and the residual (the
total depreciation over the lease) and dividing it by the number of months. In
effect, you are paying off the depreciation with equal payments each month.
Graphically, the depreciation is being paid "in a straight line" (see
figure).
But we all know that a car depreciates much more
rapidly in the earlier years with the biggest hit occurring the day you drive
the car off the lot. So when you terminate the lease before you have paid all of
the depreciation, you will likely be required to pay the difference between what
the car is worth and how much you have paid on the depreciation. This difference
is often referred to as the "gap".
Some lease contracts will really stack the deck
against you with the terms for early termination. For example, some Nissan
Motors leases require the sum of all remaining payments be made before they will
release you from the lease. Other leasing companies tack on an additional early
termination fee of $250 to $450 in addition to unpaid depreciation. Always read
the fine print of the lease contract and understand your exact liabilities for
early termination before you sign.
Insurance Cost
Leasing companies tend to require higher amounts of insurance coverage
than you may normally carry. This could impact your insurance cost considerably.
Find out what the requirements are and get an estimate from your insurance
company before signing on the dotted line.
Higher Credit Requirements
Since the expensive car you will be driving for the next 2-5 years
belongs to someone else (the leasing company), the owners want to be assured
that you will make the payments on time and will not trash their car. Therefore,
the credit worthiness standards tend to be higher for leases than conventional
loans. In other words, if you have a troubled credit history you may have
problems getting approved for a lease.
Mileage Limitations
Almost all leases limit the number of miles per year by imposing fees
typically 10 to 15 cents per mile over 15,000 miles per year. If you put a lot
of miles on a car, these fees can add up quickly.
No Ownership
Technically, when you lease a car, you are renting it. The leasing
company retains ownership of the car and you pay for the privilege of driving
(and maintaining) it. For many who have "owned" cars all their lives,
this may be a psychological barrier.
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