How Does Leasing a Car Work?

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Leasing is the practice of paying a specified amount of money over a specified time for the use of a product. Residual value is what your car is worth at the end of the lease. It’s what it would cost you to buy the car, used, at that time.

If you have a closed-end lease, you simply come to the end of your lease agreement, turn in your car, and walk away.

If you have an open-end lease, you may not be able to walk away free and clear at the end of the lease; you may owe the difference between the residual value of the car and the actual market value at the end of the lease. This might be the way to go, as long as the street value of the car has remained above the residual value determined by the dealer. You would then be buying the car for less than you could anywhere else. If the dealer overestimated the car’s residual value, however, you’d be paying more for it than you would somewhere else.

Before you decide to lease, consider some of the following pros and cons.

Pros of Leasing

There are some good reasons why people like leasing vehicles:

  • Many leases don’t require a down payment, or at least not a very high down payment.
  • You probably can lease a more expensive car than you’d be able to buy. The majority of millennial car shoppers surveyed said they would put down no more than $3,000 and pay no more than $300 a month for a new car. That would limit your purchase to a car priced at less than $20,000. For the same money, however, you could lease a car priced as high as $35,000.
  • When your lease ends, you don’t have to worry about getting rid of your car; you simply give it back.

Cons of Leasing

There are, however, some not-so-good aspects of leasing a car:

  • The total cost of leasing is almost always more expensive than buying a car with cash and can be more expensive than financing a car.
  • When your lease ends, you’re out of a car.
  • If you decide to buy the car at the end of the lease, you will owe sales tax.
  • Most lease agreements impose mileage limits. If you go over the number of miles allowed, you’ll have to pay a penalty.
  • Leasing doesn’t cover insurance or maintenance, so you don’t save these costs.
  • You might have to pay for the dealer’s cost of auctioning the car when your lease expires. These fees are called disposition charges.

Definition

Disposition charges are just a fancy name for the dealer’s costs to auction your car when your lease is over.

Before You Lease

If, after considering the pros and cons, you decide to lease a car, do your homework before you sign anything. There are as many lease deals as there are kinds of cars. Check out websites such as Edmunds.com (edmunds.com) or Bankrate (bankrate.com) for more information about leasing.

When you feel you’re sufficiently prepared to negotiate a lease, keep the following tips in mind:

  • Opt for a closed-end agreement Always get a closed-end agreement. This enables you to turn in your car and say adios. If you fall in love with your leased vehicle, you can negotiate for it, but you won’t be obligated to buy it.
  • Understand repair requirements You’re still responsible for repairs when you lease a car. Be sure you know in what condition you’re expected to return the car.
  • Also check out the manufacturer’s warranty on the car. This is a good guide as to how long your lease should be. You don’t want to end up paying for costly repairs.

Definition

A warranty is a written guarantee for the condition and performance of the car. It makes the manufacturer responsible for the repair or replacement of defective parts. Gap insurance can be included in your lease agreement and pays the difference between the value your insurance will pay if your leased car is stolen or wrecked and the amount you owe when you terminate the lease.

Find out what happens if you lease a lemon. Cars you buy are covered by lemon laws. Be sure there’s a similar provision if you lease.

Push for a higher residual value

Negotiate the highest residual value on the vehicle you can. If you decide to buy it, you can renegotiate. If you don’t buy it, you’ll end up paying less for the part of the car’s value you’ve used.

Talk about mileage

Be up front with the dealer about how many miles you plan to put on the car each year. If you exceed the dealer’s limit (usually around 15,000 miles a year), you’ll be fined.

If you drive 10,000 miles a year or less, ask whether you qualify for a low-mileage discount. Be persistent if the dealer is reluctant to give it to you.

Get gap insurance

Be sure the lease has gap insurance. Ask to have it included in the agreement with no additional charge.

Consider the length of the lease

Don’t sign a lease for longer than you’ll want the car. For instance, if there’s a possibility you’ll be transferred to Singapore for work in 2 years, don’t sign a 3-year lease. You’ll be penalized for breaking it.

Finally, don’t let a dealer talk you into a lease agreement that’s shorter than what you want. The dealer is eager to get you back into the showroom to look at another car, and some dealers push for very short leases for that reason. However, it could end up costing you more than necessary.

The more you know about leasing and lease agreements going into the showroom, the less likely a salesperson will be to take advantage of you and give you something you don’t need or want that will cost extra money. Remember these definitions:

  • Capitalized cost The price you pay for the car.
  • Finance charge The interest you pay on the car.
  • Residual value According to the dealer, the amount the car is worth when the lease is over.

Compare these numbers in every agreement you look at.

Also read up on leasing, be prepared with questions, and don’t be pressured into getting something you don’t want. If you decide to lease and follow those guidelines, you’ll do just fine.

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