Leasing a Car: Some Important Facts

A lease is an alternative method of acquiring the use of a vehicle. It is an ongoing financial arrangement whereby you (the lessee) sign a two-to four-year contract, drive the vehicle for the allotted time, return it to the lessor (the dealership) at the end of the lease, and either buy the car, enter into another lease for a new car, or walk away with no further obligation. Lease payments are generally lower than regular loan payments would be to finance the same vehicle. With loan financing, you retain ownership of the car after the final payment is made. When leasing, ownership of the vehicle remains with the lessor throughout and after the term of the lease, unless you choose to purchase it. Leasing, therefore, does not allow you to build ownership value, or equity, in the vehicle; it does, however, free you from the major expense of owning a newer car, which is depreciation.

Financers offer two types of leases: open-end and closed-end. An open-end lease requires you to pay any difference between the projected residual, or remaining, value of the vehicle and its actual market value at the end of the lease term. In other words, if the leased vehicle depreciates faster than anticipated, you’ll have to pay the difference between the expected value and the true market value at the end of the lease. The projected value of the vehicle is included in the lease agreement at inception. Open-end leases are still offered, but they have largely been replaced by closed-end leases.

Also known as a walkaway lease, the closed-end lease specifies the price at which you may, but are not compelled to, purchase the vehicle at the end of the lease. Since you don’t have to buy it, you can walk away from that vehicle and enter into another lease agreement for a new vehicle. A closed-end lease shifts the risk of overestimating the residual value of the vehicle onto the lessor, who agrees to absorb any losses that stem from rapid depreciation. You are, however, responsible for any above-normal mileage or wear. Some other facts that you should be aware of concerning leases are below.

You must normally have very good credit to qualify for a lease. A lease with a low down payment exposes the lessor to greater risk of substantial loss in the event of a default on the obligation.

Lease payments are established to provide a return on the lessor’s capital that’s invested in the leased vehicle. The lower the return that a lessor will accept, the more you’ll benefit from the lower lease payments.

Lessors normally charge a substantial penalty in the event that you decide to terminate the lease early. Therefore, only enter into a lease if you’re prepared to fulfill the terms completely.

Leases typically specify a maximum number of miles that the vehicle can be driven before excess-mileage charges begin to accrue. Generally, 15,000 annual miles are allowed. You can attempt to negotiate a higher limit if you expect to exceed the mileage allowance.

Although manufacturer defects and routine scheduled maintenance are normally covered, other costs of operating the vehicle (such as registration, insurance coverage and non-routine repairs) are yours to pay.

Most leases require a nonrefundable down payment, usually from $1,000 to $2,000, depending on the value of the vehicle. A security deposit, which is generally refundable, may also be required. Sales taxes, if applicable, are usually added to each lease payment.

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