Should I Lease My Next Car?
Automobile Leasing Explained

A recent article in Motor Trend cited the results of a study performed by AAA showing that the average cost of car ownership is over $7,800 per year. Of that amount, almost $3,400 is depreciation, making it the largest single component of the overall cost of vehicle ownership. There are so many factors that can affect the depreciation of your automobile, and most of those factors are totally beyond your control. This means that when you buy a car, you have no idea how much it will cost you to drive that vehicle until the time that you trade it in or sell it, thus finding out how much the vehicle has depreciated. In the meantime, that is your money rolling down the street.

Wouldn't it be nice to know at the time that you buy a car, exactly how much you are going to pay for the depreciation during the time that you drive the vehicle, instead of leaving it to chance? Well, ladies and gentlemen, your wish is granted. There is a way, and it is called LEASING.

Whatever horrible things that you have heard about leasing, I have probably heard it too. Most of the negativity regarding leasing is based upon misunderstanding, or upon a misperception of what leasing is today because of the consumer horror stories from 20 years ago. In the 1980's, there were open-end leases available in the automobile retail industry. These were horrible arrangements where the future value or "residual value" of the leased vehicle was determined in the future, based upon the used car market at the time. --" Wait a minute...isn't that a lot like when you buy a car and have to trade it in at market value when you are finished using it? " -- OK, regardless of the similarity, open-end leases are now illegal. When you lease a vehicle today, the residual value is established up front, so there are no surprises at the end. This is called a closed-end lease.

Another horror story that one often hears about leasing is that someone's brother's next door neighbor's son in law's fist cousin on his mother's side had to pay a huge mileage penalty at the end of the lease. That has happened; in fact, I've seen it happen, where a person did not understand the impact of entering into a low mileage lease that did not match their actual usage. However, this would never happen to an informed lessee...you know, someone like you after you read this article. An informed lessee would have been more realistic in estimating their usage, and would have built sufficient miles into the lease to cover that usage. I'll discuss this more, down the page a little further.

In my years of selling and leasing cars, I heard many objections, but my all time favorite objection to leasing is: "When you lease you don't own the car, and I own my cars!" If you are financing your car, you do not own it until you make your last payment, and the bank hands over the title. Until that time, the bank owns your car. The worst part of that deal is that you, not the bank, YOU are responsible for any potential loss due to the depreciation of the value of that car, and you won't know how much that is until you go to sell it or trade it in.

In a lease, the lender determines how much that a particular make and model vehicle should depreciate within a certain time frame and mileage. This is expressed as a percentage of the M.S.R.P. of the vehicle, and it is called the residual value. This is the price of the vehicle if you decide to buy it at the end of the lease term. If you do not want to buy the vehicle at the end of the lease term, and if, at that time, the actual cash value of the car is less than the residual value, it's not your problem. Turn it in; the leasing company has to deal with liquidating their asset based upon the used car market of the time. If, however, that vehicle is worth more than its residual value, that money is yours to use if you so desire. If this is the case, then trade the car in on another, and use the equity to lower your payment on your next lease.

Here is an example that illustrates the point that I am trying to make about your risk and depreciation:

In the following example, I am comparing a 36 month lease and a 60 month purchase, keeping as many factors as possible consistent between the two examples. In this example, the cap cost of the lease and the MSRP of the vehicle being leased are $20,000, with a 36 month residual of 50%, and an interest rate of 6%. The 60 month finance example is based on a total amount financed of $20,000 and an interest rate of 6%.

Let's assume that at the end of three years, the vehicle's Actual Cash Value is the same as the residual value, $10,000.

The person buying the vehicle would have equity of $1,276 (ACV minus payoff = equity). However, that person also paid $13,919 over three years of payments; this amount is $1,231 more than the $12,688 that our Lessee paid over the same period of time. Although the Lessee has no equity, positive or negative, the buyer's equity is offset by the $1,231 spent in higher payments, making it about a draw as far as which scenario is better from a bottom line perspective.

Now, let's assume that the vehicle is worth more than the residual value of $10,000, and that the Actual Cash Value is $11,000.

If that were the case, then both the person leasing, and the person financing would have an additional $1,000 equity that they could use when trading in the car. So in both of these scenarios, it would be pretty much a draw when looking at the bottom line, except that the person leasing had a smaller outgoing cashflow because of the lower payments, and did not have any risk of financial loss if the trade in Actual Cash Value would happen to fall below the residual value of $10,000.

Risk, based on unknown depreciation, and risk, based upon other unknown factors that could diminish the vehicle's value are the biggest reasons to lease. Let's say, in our example above, something happens that affects the value of the model in question, like rising gas prices, massive recalls, enhanced manufacturer incentives on the newer models, or that it gets damaged to the extent that the title is branded with a damage disclosure. Let us assume that in light of one or more of the above, the car is now only worth $8,000 at the end of 36 months.

If that was the case, then the person financing it still owes $8,724, so in addition to having spent $1,231 more than our Lessee, he is also $724 upside down (upside down is a common term for having negative equity). While the person who is purchasing his vehicle is no doubt upset and disappointed, our Lessee is smiling ear to ear, because not only did he spend less money over the 36 month period, but also he is turning in the vehicle, owing nothing, thus having spent a total of almost $2,000 less than his friend who bought the same vehicle.

The net of the whole idea of leasing is that in a lease, you only pay for the portion of the car's value that you will use during the time that you drive it, and you do so without risking your own capital to wager on the vehicle's future value. Right about now, leasing is probably starting to look pretty good. Read on -- it gets even better.

"I drive 25,000 miles per year, and that's too many miles to lease a car." This is another common objection, but if your mileage is above average, that is even more of a reason to lease. Most leasing companies establish residual percentages for the vehicles that they lease based upon usage of either 12,000 or 15,000 miles per year representing what is commonly regarded as average mileage. Extra mileage can be built into a lease, in most cases at a rate of $0.10 per mile. When you consider that in evaluating a used vehicle, a mileage penalty of $.25 to $.30 per mile is deducted from the value for any mileage over 15,000, then leasing is still a bargain. The reality here is that if you drive a vehicle over average miles, then you will pay for that usage through accelerated depreciation of the vehicle's future value. By building additional miles into a lease at a lower per mile rate, one can control and diminish the effect of the accelerated depreciation due to excess usage. In other words, you're going to pay for the excess driving one way or another; leasing is just a cheaper way to do it.

Aside from eliminating your risk of depreciation, here are some more reasons why you should lease your next new vehicle:

• You get more car for the money
• Ability to trade cars every three years without the hassle of trade-ins and negative equity.
• Lower debt shows on your credit report since only the sum of payments is considered to be your debt, rather than the entire cost of the vehicle as is the case with an installment loan. This results in a lower debt:income ratio, therefore a better credit score.

Since I sold new Honda vehicles, American Honda Finance Company lease programs are what I know best. Everything that I have said so far applies to auto leasing in general, but here are some leasing advantages that are specific to Honda:

• G.A.P. is included at no extra cost, in every Honda lease. Guranteed Asset Protection covers the difference between the loan payoff and the actual cash value of the vehicle if it is in an accident and determined to be a total loss. Therefore, if the vehicle is totaled, you pay your insurance deductible (if applicable), and walk away owing nothing.
• $1,500 excess wear and tear waiver. There are some specific coverage parameters in this waiver. Please refer to the lease agreement for details.

Honda is an excellent vehicle to lease, not only because of the reasons stated above, but also because Honda builds a high quality vehicle that holds its value exceptionally well, and therefore has a high residual value. This means that even without a special lease program, the high residual value will result in a lower payment since your payments are based upon the cap cost minus the residual. Honda often runs special lease programs on selected models. When Honda runs a special program, the lease money factors are lower, making the lease an even better deal.

If you are reading this sentence, then you have endured a pretty healthy dose of my verbosity as I have expounded upon the virtues and value of leasing. I thank you, and I hope that what you have read has been informative and helpful. In parting, I will say to you that I am firmly convinced that, while leasing might not be for everyone, there are many people who should be leasing, and are not. The main reason why people don't lease their vehicles is that they simply do not understand what leasing is all about and how it can be of benefit to them. I hope that now you have a better understanding of automobile leasing, and that you will consider leasing the next time that you are in the market for a new vehicle.