One advantage of leasing is that you can drive more car for less money.
Maybe you’re doing a double-take right now thinking, “Did I read that right?” To understand this little nugget of wisdom, here’s a brief (I promise) explanation of how cars depreciate and why that affects your lease payment.
When you buy a car, you pay for its full value all at once, usually by taking out an auto loan. But when you lease, you just pay for the amount of the car’s value you use. So if the lease lasts for three years, you pay for three years of the car’s value. Keep in mind, though, that you are getting the first three years of the car’s life, when it is brand spanking new. Those years are worth more than, say, the fourth, fifth and sixth years, when it’s battered and dinged and the upholstery smells like french fries.
Now, here’s a fun fact: If you choose a car that holds its value and depreciates less, your lease payment will be lower. This is why you can drive more car for less money when you lease.
What is residual value?
In lease-speak, a car that doesn’t depreciate quickly has a strong “residual value.” This means the residual — the amount that’s left — is still high.
To better understand how it works, let’s look at two scenarios.
An uninformed shopper. This poor guy leases a $30,000 car with a weak residual value. It loses half its value — $15,000 — over the three years of the lease. He pays for the depreciation, $15,000, divided into 36 monthly payments of about $417 (plus fees).
The savvy shopper. Since you’re a smart shopper and you’ve done a little research, you pick a different model car that also sells for $30,000 but only loses $10,000 in depreciation over three years of the lease. So you drive a better car and pay only $278 per month ($10,000 divided by 36, plus those nasty fees).
Guessing a car’s future
When a lending company sets up a lease, it guesses what the car will be worth at the end of the contract, usually three years. For common cars, such as a Honda Accord, that’s pretty easy to do since that car’s been around forever and the banks can predict what it will be worth. Usually, the Accord’s residual value is about 55%.
So, tip No. 1: Find cars that have a high residual value. Many car websites and magazines publish annual lists of good lease cars. Search for “best residual values.”
Review lease ads carefully
When a car isn’t selling quickly enough, the manufacturer advertises special leasing offers to move the metal. These widely advertised deals provide a low monthly payment by tweaking the leasing formula in one of several ways, such as reducing the sales price or offering a low interest rate. To see if it really is a good deal, make sure you read the entire ad, including the fine print.
Monthly payment. Keep in mind that this seemingly attractive monthly payment usually doesn’t include sales tax and fees and is usually a “stripper” — a car that is stripped down with few options.
Length of the lease. The “sweet spot” for leasing is 36 months, because then you’re always under the included bumper-to-bumper warranty. But leases often are advertised for different lengths. If you see a lease ad with a low monthly payment, but it’s for 48 months, it’s not such a great deal.
Drive-off fees. This is the money you pay at the beginning of the lease. To arrive at a low monthly payment, these lease specials will often require high drive-off fees. It’s best to make a low drive-off payment of about $1,000 even though the monthly payments will then be higher.
Included miles. Most lease contracts include 12,000 a year or 36,000 total for a three-year lease. Lately, though, some leases with low monthly payments have a catch: You can only drive them for 10,000 per year or pay an additional charge for each extra mile. This means that you are getting less value.
Calculating total costs
Remember that you won’t ever own this car (unless you opt to buy it at the end of the lease). So, after three years, you will have spent a certain amount of money in monthly payments and fees. If you add up all the charges listed above, you will know how much your out-of-pocket costs will be for the use of the car. Use an auto lease calculator to see a breakdown of monthly taxes and interest and how changing various elements of the lease affects your monthly payment.
For example, if you see monthly payments of $299, add the estimated sales tax; in California, it would be $27, making the total monthly payment $326. Multiply the real monthly payment by the number of months: $326 x 36 = $11,736. Add your drive-off fees for a grand total of $12,736 (plus insurance, maintenance and gas).
Now find a good lease car
Once you understand how depreciation changes the monthly payment and how carmakers advertise their leases, you can use your X-ray vision to find the best lease deal possible.
Philip Reed is a staff writer at NerdWallet, a personal finance website. Email: firstname.lastname@example.org.