by Archie M. Richards, Jr., CFP^®
June 14, 2004

Leasing is not the cheapest way to obtain automobile transportation. To minimize the cost, buy a good-quality used car one or two years old. Offer less than the posted price. Pay cash. Keep the car in good condition and run it until the repairs become a pain. Sell and repeat.

If you prefer a new car and you drive a lot, buy a new car without a loan. Offer significantly less than the manufacturer’s suggested retail price (MSRP), which is the sticker price displayed on the window.

If you prefer a new car and you do not drive much, consider leasing. Here are the key elements of leasing an automobile:

Choose a car you like and make believe you’re going to buy. Offer less than the MSRP. After the price has been negotiated, disclose that you prefer a lease.

The estimate of what the car will be worth at the end of the lease (not taking into account wear and tear) is called the “residual value.” The longer the lease, the lower the residual value, generally stated as a percentage of the MSRP. You probably won’t be allowed to negotiate the residual value, but you can always try. Most of the cost of a lease is the difference between the purchase price and the residual value, in effect, the car’s depreciation. You want the purchase price to be low and the residual value high.

Make sure the lease is “closed-end.” When the lease is up, you want to be able to walk away regardless of what the car is worth (other than wear and tear). With an “open-end” lease, if the car’s actual value at the end is lower than the residual value estimated at the beginning, you must pay the difference. A closed-end lease is better.

The lease probably requires you to maintain the car on a rigid schedule. If you’re not accustomed to keeping your car in good condition, forget about leasing. Buy a car instead.

You must obtain automobile insurance, amply covering liability and damage to the car.

A downpayment is usually called for. With a lease, the amount is lower than if you buy the car outright.

The lease includes an annual interest rate. Except for your downpayment, you’re borrowing the car’s cost. Some leases refer to the interest as a “lease factor.” This is a small number that is multiplied by 2400 to calculate the annual rate. If the lease factor is 0.00167, for example, your actual interest rate is 4 percent (0.00167 times 2400).

Your lease will probably include four fees, as follows:

• Excess mileage fee, covering the number of miles you drive each year over a specified breakpoint. Choose a breakpoint that suits you. Most contracts offer choices between 10,000 and 20,000 miles. Say you select a 2-year lease with a breakpoint of 15,000. You’re allowed 30,000 miles for the 2 years. If you end up driving 34,000 miles, you’ll be charged a fee of perhaps $.15 or $.20 a mile for the extra 4000 miles. If you can estimate the extra mileage in advance, reduce the cost by paying the fee up front. If the contract you’re offered doesn’t specify a breakpoint, the dealer is unreliable. You should find another.
• Acquisition fee, ranging from $750 to $1000. Despite the name, this does not compensate the dealer for buying the car; it compensates the bank (or the manufacturer) for providing the lease.
• Disposition fee. This compensates the dealer for selling the vehicle at the end of the lease. It’s usually waived if you buy the vehicle or lease another.
• Wear and tear, assessed by the bank or the manufacturer from whom the lease is obtained.

For maximum savings, buy a used car for cash. But for low-mileage driving with a late-model car, leasing may be just the ticket.

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