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Introduction

What is a lease?

The Mathematics of Leasing

Lease Calculator

 

What is a Lease?

Let’s take the simple approach in answering this question first, then we’ll move on to the more involved answer.

First of all, since we are discussing vehicle leasing, I will use the word "lease” without reference to the vehicle part from now on.  We will not be discussing equipment leasing, apartment leasing, or skyscraper leasing in this guide, so when I say leasing, I mean vehicle leasing. OK?

A lease is a very simply a method of acquiring a vehicle that would fall somewhere between renting a vehicle and owning a vehicle.

Let’s clarify some terms before we get too deep into this discussion.

Lessor – No this is not the opposite of “Greater”.  The bank, leasing company, manufacturer owned finance company, etc., is the lessor, and YOU are the Lessee. Think of it in terms of a bank loan and the Lender is the Lessor, and the borrower is the Lessee. Simple, eh? We have included a glossary of terms so you can brush up on the lingo of leasing. It’s helpful to know what the Lessor is talking about during negotiations.

A lease is a way of financing the purchase or use of a vehicle.  Simple, right?  It really is just that simple.  Most people are familiar with the other method of financing which is installment financing.  With installment financing you create an obligation, or loan, with the lender, let’s call it “the bank”, to repay a specified amount of money which you borrowed from them to purchase a vehicle.  They will use the vehicle you are purchasing as collateral, or value, against the chance that you may not repay the loan.  The bank is very careful about who they lend money to and they want some assurance they  will get their money back.  The bank places a lien, or claim, on your vehicle so that in the event you don’t repay the money they will own the car.  They don’t really want your car but it is an inducement for you to repay them on time and in full.

They will charge you interest on that obligation which increases the amount of your obligation and must also be paid to satisfy your debt.  Once you have paid that total obligation you own the car.  End of story.  You’re happy and the bank is happy.  They got all the money back and some and you got to own your car.  Or should I say you got to own your old car.  An average installment loan is 48 months which means you have successfully purchased a FOUR YEAR OLD AUTOMOBILE.  Since the average consumer trades his car every 2.5 years, either because they’re tired of it or it’s worn out, the obligation to the bank is not fully satisfied.  What to do now?  You still owe money on the car, but you don’t want it anymore.  Well, for one thing, RULE #1 is the bank is always going to get its money.  Accept that fact now. 

When you drive your two and a half year old car into your friendly car dealer you expect that he will take that heap off your hands and replace it with a shiny new one and you are only on the hook for the new one, but you are SO wrong.  If your car is worth $10,000 and you owe $12,000, you will either pay the difference in cash or add it to the amount you finance on your new car.  If your car is worth $10,000 and you owe $8,000, you have equity or value in your car and that money will decrease the amount you owe on your new car.  At this point you might be saying to yourself, “The last time I traded my $10,000 car I got the dealer to pay it off for me.  He gave me $12,000 for it.” 

Fig. 1              

Purchase Price of Vehicle  

$20,000

Minus Trade Allowance

$12,000

Plus Payoff to the bank

$12,000

Amount you will finance

$20,000 plus taxes and fees

Fig. 2

Purchase Price of Vehicle  

$18,000

Minus Trade Allowance

$10,000

Plus Payoff to the bank

$12,000

Amount you will finance

$20,000 plus taxes and fees

Fig. 3

Purchase Price of Vehicle  

$18,000

Minus Trade Allowance

$10,000

Plus Payoff to the bank

$10,000

Amount you will finance

$18,000 plus taxes and fees

In all three examples, the amount due your lender, the bank, remains constant.  That is about the only constant in buying a car.  Remember RULE #1, the bank always gets their money.  The car dealer may play with the numbers, often on your behalf, but the bottom line is you will pay X dollars for the new car, your old car is worth Y, and the payoff is always Z.  So, X-Y+Z = what you always pay for the new car.

Leasing is very similar to Buying when it comes to driving a new car.  In both cases you get the use of the car even though the bank holds a lien on it.  You create an obligation to the bank which you must satisfy, just as you did with installment financing.  You may dispose of the car at anytime you wish just as with installment financing.  And, as in installment financing, when you decide to dispose of the car you must payoff the bank any amounts due that the sale or trade of the car does not cover.

Unlike installment financing, at the end of your agreement with the bank, you do not own the car.  Unlike installment financing, you do, however, know what the car is worth to the bank at the end of your agreement.  That amount is specified on the lease agreement at time of signing.

Let us say that you agreed that you car lease end (residual) value would be $12,000. Now the lease has come to an end, the car you choose is now only worth $8,000. And unlike installment financing, you are not on the hook for that $4,000 difference in value of the car. You do, in fact, walk away. You may have to pay a small disposition fee if you have decided to turn the car in to the bank instead of trading it on a newer model, but that’s it. Your obligation is done.

So, now What is a Lease? A lease is a way to drive a car for a specified length of time and only pay for the part of the car you use. Say that again?

If you buy a $20,000 car and keep it three years, you have used only three years of the cars life expectancy. But you paid for the entire car didn’t you. If you lease a car, you pay for the three years of use and the remaining life of the car is residualized.  Here’s and example:

 
Lease
Buy
Value of new car $20,000 $20,000
 Amount you paid $20,000
plus interest
$10,000
plus interest
Amount you owe         $0 $10,000
 Value of Car in three years $10,000 $10,000
Net to you $10,000 $10,000
plus interest EARNED

Have trouble following the math? Let’s go through the numbers. The buyer paid for the whole car and at the end of three years sold the car and recouped $10,000. The lessee leased the same car, paid only $10,000 for the same three years and has the $10,000 that he never spent earning interest for three years. Even if the buyer paid cash, he is still expensed the entire car up front. When was the last time you made an investment where your broker told you that he had a stock for you that as $10.00 a share and he could guarantee that it would be worth $5.00 a share in three years. How many shares would you buy? Not many I’m guessing.

Again, leasing is a way to drive more car for less money. Or, leasing is a way to drive more car for the same money as you would has spent on less car.

When renting a vehicle you assume an obligation to pay a certain amount in installments for the USE of the vehicle. These installments are generally daily, weekly, or even monthly in some circumstances. This payment does not imply ownership of the vehicle, and no obligation beyond returning the vehicle in the same condition as you received it.

When you purchase a vehicle, either by cash or credit, you assume the full responsibility for the vehicle because you OWN it. It's yours. You can drive it off a cliff if you choose, and short of a scuffle with the insurance company and an interview with a psychiatrist, no one cares because it was your loss. But, if you take reasonably good care of your vehicle, some where down the line it will return a percentage of the original price you paid for it as a thank you.

Leasing a vehicle is a pleasant blend of the above two examples. You only pay for the portion of the vehicle that you intend to use and you get to treat it like it's your own. You undertake a long term obligation, you register the vehicle in your name, and the lessor, you buy license plates, you take it on trips, and you wreck and get it repaired. Come the end of the predetermined period you chose to use this vehicle, you give it back to the lessor, say thank you, and go on to the next exciting model. No, it's not always that easy. But, there are also more options that we will discuss later.  That’s it, and it’s that simple.

 

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