How does a car lease work?

Webster's Dictionary defines a lease as "a contract by which one conveys real estate, equipment, or facilities for a specified term and for a specified rent." In other words, a car lease is a fancy way of saying you will be renting a car. But not like the typical car rental. With a car lease you are paying monthly installments, which will reflect an interest rate as well as the depreciation of the value of the car you are leasing.
 
While most people think they are leasing from a car dealership, in reality you are leasing it from a leasing company. The dealership sells the car to the leasing company, who then lease it to the consumer under the terms agreed upon between the consumer and the dealer. These terms include the capitalized cost, the monthly payments, the length of the lease and the interest rate.

Is there only one kind of car lease?

No, there are two kinds. They are referred to as closed-end leases and open-end leases.
 
Closed-end lease - In a closed-end car lease, you may return the car at the end of the lease and "walk away." However, you're still going to be responsible for certain end-of-lease charges, such as excess mileage, wear and tear, and disposition. You also have an option to purchase the car at the end of the lease. The residual value of the car at the end of the lease had already been determined when you initially signed the lease. If you choose, you may pay the residual value of the car plus a processing fee, and the car is yours. This is the most popular type of car lease.
 
Open-end lease - An open-end lease should only be considered for commercial business leases. In an open-end lease, the market value of the car is determined at the end of the lease contract. This is then compared to the pre-determined residual value of the car, and cha-ching! You pay the difference, which can be quite hefty.

What are the advantages of a car lease?

Depending on your needs, there are specific advantages to leasing a car. Here you will hopefully learn some of them, which should help you determine if the lease is the way to go.
 
Here are some advantages to consider:
 
Lower Monthly Car Payments - The monthly payment from a lease will be lower than the monthly on a purchase. The reason behind this is that on a lease, you are not paying for the whole car, just the portion of the car's value over the lease period. Monthly payments on a lease can be up to 60% less. Therefore, for the same price, you can drive a nicer car under a car lease than under a conventional loan.
 
Lower Upfront Costs - Down payments on a lease are usually much smaller as well. Generally you will pay a deposit of your first monthly payment, as well as tax, title and registration fees where applicable. You may elect to pay a larger down payment to reduce your monthly payments.

How do I calculate a car lease payment?

Don't worry. You don't need to be Archimedes to figure out a car lease payment. There a few numbers you will need to find out in order to plug them into a simple equation. Once this is done, the result will tell you what your monthly payment will be. These are numbers that can be made available by a dealer, in accordance with the Federal Consumer Leasing Act. (The dealer is not required to give you the money factor, however, you can get it if you are persistent. The money factor is roughly equivalent to an APR divided by 2,400.)
 
First, we need to figure out the monthly depreciation of the vehicle. To find this, subtract the residual value of the vehicle from the cap cost. Take the difference and divide it by the number of months you plan to lease the car. This calculates the monthly depreciation.
 
Next we will tackle the monthly finance charge. This time add the residual value and the cap cost, then multiply that by the money factor. This results in the monthly finance charge.
 
Now, simply add the monthly depreciation and the monthly finance charge, and you have calculated your monthly car payment.

What kinds of scams should I be aware of?

All of them, really. Unfortunately there are a number of scams some of the more unscrupulous car dealers will try to pull. But after reading below, you will be aware of these shams and ruin a shady dealer's attempt to rip you off.

The Secret Price Hike

This one is said to be the most common scam out there, most likely because it is easy to pull off. Here's how it works: You negotiate with the dealer over the price of the vehicle. After a while, he or she gives in, and gives you a good price. The dealer may even remark on you negotiating, pointing out how you have skills. Then when the dealer leaves to write up the paperwork and returns for you to sign. You do so, not noticing the dealer added more to the monthly payment. And since you've already signed, you're locked in. And you can rarely get out. The lesson? Always do the calculations yourself. Make sure you get all of the pertinent numbers from the dealer; the residual value, the money factor, taxes, down payment, rebates, etc. Check the dealer's math. If the figures come up wrong, don't sign the contract.

The Disappearing Trade-In

This is a simple yet profitable scam. The dealer simply leaves your trade-in off the contract. They will also do this with the rebate. Or, the more creative shysters will create some random fee that is about the same price as your trade-in value or your rebate. Once again, always do your own calculations and double-check the dealer.

The Phony Car Lease vs. Car Loan Comparison

A dealer may present you with a car lease vs. car loan comparison in which he or she will claim that it illustrates that one is better than the other. This is bunk. Never trust a car lease vs. car loan comparison. They are almost always rigged, and are potential set-ups for the Secret Price Hike or the Disappearing Trade-In.

Are there any disadvantages to a car lease?

Just like the advantages, there are disadvantages to leasing a car depending on your needs. Some things to consider:
 
Early Termination of the Car Lease - There are most likely fees involved in the early termination of a lease, fees for which you will be responsible to pay. Early termination can be involuntary as well. If the vehicle is stolen and not recovered, or totaled in an accident, the lease is forced to end. Very often your insurance reimbursement will not cover the entire balance due on the lease. Therefore you pay the rest. However, many leasing companies offer gap insurance, which provides you financial protection in such an event.
 
Also, when paying a car lease, you are paying for the depreciation plus interest. The depreciation is calculated as the difference between the cap cost and the residual value. While the depreciation is paid off evenly over the lease term, the depreciation of a car is not linear. The difference in the actual depreciation and the paid depreciation is known as the gap amount, and will also be paid in a prematurely terminated lease.
 
Additionally, some leasing companies will require you to pay off the remainder of the car lease contract before releasing you from the lease. Others will require a flat rate termination fee. Make sure you read all the fine print before signing your lease contract.
 
Insurance Costs - Leasing a car can bring on higher insurance rates since you may require more coverage than you're used to paying. Contact your insurance agent to get an idea of what you insurance costs will be before signing a lease.
 
Car Mileage - Most leases have a limit on the number of miles you may drive, usually anywhere between 12,000 and 15,000 allowable miles per year. Excessive mileage equals more money, usually about 10 to 15 cents per mile over the agreed upon yearly figure. This can add up fast, especially if you drive a lot.
 
Wear and Tear - Like mileage, there are limitations on the wear of a vehicle under a lease. Exceeding these wear limitations may result in more fees.
 
Credit worthiness - Since the car you will be driving belongs to someone else, that someone else needs to be confident that you will keep the car in good condition and make your payments on time. This means that credit requirements are more stringent on potentially leasing a car. Therefore, if your credit history is spotty, your chances of getting approved for a lease will be spotty as well.

How do I negotiate a car lease?

Other than actually paying money, this is my least favorite part of leasing a car.
 
Generally, the negotiating process is clear and straightforward, without headaches. But you need to be on your toes at all times in order to not get taken for a ride. Negotiating can be tricky, especially since we are conditioned to think that the dealer is trying to pull a fast one. Yes, a dealer's goal is to make money. But that doesn't mean they are going to jeopardize their job to do so. Sure, there are exceptions to the rule, but most dealers are going to give you a square deal. But during negotiations, be sure to get everything in writing, even when the dealer simply states a number. Once it's written down, the car dealer can't go back on his or her word.
 
And always remember: You are in control. You are the one who decides whether or not the terms of the deal are fair. After all, if you don't like them, you can walk away. The dealer is dependent upon you for a deal. If a deal is not made, the dealer loses the sale and earns no money.
 
One strategy to take in the negotiations is to work out a reasonable purchase price before you let the dealer know you intend to lease. By not tipping your hand, the dealer may be under the impression you plan on buying the car. If a dealer knows from the beginning that you plan to lease the vehicle, he or she can waylay you by using leasing terms to conceal the real sale price on the car. But this method can thwart such a tactic. The drawback to this method is that it is quite time consuming because you will not reveal your intention to lease until the very end of the negotiating process. It is only after that you will receive the money factor and the residual value. Then you will be able to see if you can afford the lease payments, or if the rates are reasonable. If you can invest the time, this is an effective approach.
 
Another strategy will help you avoid the uncertainty of previous method. Work with two dealers at once on the same model. Manufacturers usually offer the same car lease program throughout for each model, so you will get pretty accurate numbers. Be sure to ask specifically for the money factor and the residual value. These numbers will vary depending on the length of the lease. Get these numbers in writing from the dealer, again to avoid any disagreements.
 
Your best negotiating ammunition is knowledge. The more you know about the information above, about the key terms, the calculations of the different figures, the better off you'll be. Bring a calculator and a pad and pen. Go in confidant, informed and educated.

The Money Factor/APR Switch

This scam may seem like an obvious one to see coming, but it can easily fly under your scam-detection radar if you're not careful. As we learned earlier, the money factor and the APR can both be expressed as decimals. However they are not interchangeable, though they can appear similar. But if you're not careful to see this trick, the difference in the decimals can cost you around $2000.

The Early Termination Scam

This is a scam to watch out for even if you plan to keep the car for the entire car lease, because an early termination can come without warning. The idea behind this scam is that, in the event of an early termination, a dealer will jack up the early termination fee and pocket the difference. To do this, the dealer will often need to work in tandem with the car leasing company. However it can easily be pulled off. The details of car leasing contracts can be quite confusing, and since it isn't as much of a concern to the lessee as monthly payments or interest rates, the early termination fee can be overlooked. When negotiating your lease, make sure you iron out this detail in case you need to exercise the early termination. And be sure to read the details before beginning early termination process.

The Single-Payment Car Lease Scam

Some people opt for a single-payment lease, which allows you to pay for the lease up front rather than making monthly payments. By paying the lump sum, you can lower the lease rate and save money over the long haul. But the crafty dealer will charge you the normal lease rate, cheating you out of your savings. Once again, do your own calculations and you won't get shafted by the dealer.

The "Options" Car Lease

The "Options" Car Lease can be a tricky one to catch, but equally tricky to pull off, considering the dealer who practices this sham is ripping off the leasing company as well. This makes it dicey for the dealer, because if they catch a dealer ripping them off, the dealer is through. For this reason, the "Options" Car Lease is rarely practiced. The idea of the scam is simple: Mark up the gap cost and the residual value by "adding" options that can go undetected. For example, they can tell you that you have a sport suspension or a higher end stereo system, but without really inspecting you have to take their word for it. As you've probably guessed, you won't get the sport suspension or the higher end stereo system, but you'll pay for it, and the dealer will pocket your cash. This scam could also work on the back end. When you turn the car in at the end of the lease, the dealer could charge you for the missing components, like super-hydraulic struts or a surround sound stereo. How do you avoid this one? First obtain the MSRP from two places other than the dealer and use them to compare the sticker price at the dealership. With these you can find out the gap cost and the residual to make sure all of it adds up correctly.

The Undisclosed Acquisition Fee

An acquisition fee is required by most leasing companies in order to open a lease. This fee, also known as a lease origination fee, is usually around $450, but can be as high as $700. Originally this fee was invented by the dealers, who would claim the car leasing company charged the fee. The dealer would then pocket the fee. But the leasing companies caught on, and began charging the acquisition fee on their own. The dealers are trained to integrate the acquisition fee into the lease in order to let it go unnoticed. To avoid this, always ask for everything, every single dollar on your lease agreement, to be itemized and explained clearly. This way you can save yourself from paying these or other hidden costs.

The Extended Auto Warranty

An extended warranty can be a great thing for a car owner. However, when you're leasing a car, you don't own the car. Also, since your car lease term will most likely last five years or less, the leased car will be under warranty for the entire duration. Therefore, the warranty is a waste of money and a way for the dealer to make money. They'll tell you things in an attempt to sway you. They'll tell you it'll increase the value of the car at the end of the lease, but you won't own the car at the end of the lease. They'll say that the extended auto warranty is refundable, but forget to tell you that it'll be prorated and pretty much worthless by the end of the lease. A good rule of thumb: Never sign a lease for longer than the manufacturer's normal warranty. That way, you'll always be covered and you'll avoid the need to extend a warranty.

The Bogus Trade-In

This scam is actually initiated by the lessee. Sometimes when a lease is running, you can get the urge to end it early and get yourself a newer ride. But don't make this mistake. There is no such thing as trading in your lease. When you are doing this you are terminating the lease early, which comes with fines. However the dealer will be more than happy to "trade-in" your lease. What the dealer will do is carry over all the penalties and fees from the early termination onto the new lease. You will then pay them, but with interest. To avoid this scam, don't "trade in" your leased car.

And More...

There are other ways for the dealer to rip you off after you sign a car lease. Known as "Call-Back Scams," a dealer will phone you about a month after you've signed the lease and inform you of an error in your contract. They will attempt to minimize the overall effect it will have, saying it'll only cost you $5 or $6 more a month. Then when you get to the dealership to sign your "corrected" contract, it'll be closer to $13 or $14 more a month. Or, they will try to get you to renegotiate your existing contract to a longer lease, but at a higher percentage. Don't be fooled into thinking you have to pay more or you have to renegotiate. It's just a way to get more money from you. And they have no right to rescind on an existing lease contract, unless you are delinquent on payments. But think about it. Do you believe that if you called the dealer and said you wanted to renegotiate your contract for a lower percentage, they would do so? No way. So why should you? If your dealer calls you with any demand for more money or for a renegotiation of your car lease contract, ask them to put it in writing so you can show it to an attorney. See if they still make their demands after that. However if they do so, follow through and consult an attorney. Chances are the dealer is making a bogus claim and the attorney will catch it. But by all means, if this happens, do not sign anything without consulting an attorney.