Are you considering a lease on a new car? In some specific cases, leasing a car is a better idea than buying, but only if you understand the ins and out of leasing. In this article, we cover a number of points that will help you see if an leasing a car is the right option for you, and what you should watch for.

1.Understand the total cost of the vehicle. Even if you do not know the first thing about leasing, do some simple match and multiply the payment amount by the number of months, account for rebates and incentives, include your own payment (if any), and then add the value of the car at the end of the lease term (otherwise known as the “residual value”).

Here’s the formula:

Payment Amount *(term) + Rebates + Incentives + Down payment + Amount due at Lease end = The total cost of the vehicle.

Why should you do this? It’s simple…this little bit of match allows you to the lease to a traditional car loan. Normally, the lease package should be close in terms of overall cost to a traditional loan. The lease terms and interest rate may vary a bit, but it remains a goog high-level indicator of a fair deal. If the dealer tells you that lease rates are higher because the bank is only offering low interest rates for loans, then perhaps you should not choose a lease. In practice, this shouldn’t happen often: If a bank can offer a low interest rate they can also offer a low lease rate.

2. Know the terms of a current traditional car loan! This is important for step 1. Calculate the cost of the car using interest rates from 1 to 7% and terms of 36 to 60 months. If you don’t know how to do this find an online loan amortization calculator. You just calculate the payment for typical current interest rates offered for new cars (in the range of 1 to 7 percent) and remember to account for any rebates or buyer incentives and rebates, and also the down payment.

Now you should have two deals to compare. If the total cost of your lease in (step 1) is reasonably close to the total cost of financing the car (step two, using a 6% rate), then you know you’re looking at a lease deal that’s similar to buying the car at a 6% interest rate. If, however, the dealer is offering something special on a purchase, like perhaps a 0% interest rate, then you know that the lease isn’t as a good a deal, and you have some negotiating to do.

3. Now that you ‘ve compared the total cost of your lease and found what the comparable interest rate loan is, how do you tell if it’s a good deal? This is the point where a lease becomes confusing for most people. The answer is “no” if your plans are to return the car at the end of the lease. Why is that? Leasing is basically taking out a loan to finance the depreciation on the vehicle. You’ve probably heard the saying “a car loses 20% of it’s value the minute you drive it off the lot”. This is very close to being true. The depreciation, or “loss in value” is what your lease payments are financing. That means that if you pay a higher amount than the actual depreciation, it’s not a great deal.

4. Do not make a large down payment! Remember that the lease is paying off the estimated amount of depreciation on the vehicle. If you make a large down payment, the dealer can then allot that down payment to offset the residual value of the vehicle While this will allow for a low monthly payment, it almost forces you to keep the car at the end of the lease, because that’s what your down payment reduced…the residual value.

5. If you shouldn’t make a large down payment, how much should you pay up front? The best answer is $0…nothing. That said, not all vehicle, or all purchasers, will qualify for a zero down payment. Calculate the following: payments*term + down payment + rebates and incentives. Look at that number and then ask yourself is this how much the car is going to loss value in over the term I am looking at? For example, if you do this math on a 30K car that you want to lease for 36 months and the value equals 20K, then something is wrong. Either you payment is to high, you down payment is to high, or they did not give you the rebates. Warning, when doing this compare keep in mind that you pay interest in the lease based on the lease factor so your numbers may be off a little depending on the lease factor they gave you. If you did step one and two, then you know you approximate equivalent interest rate and you should be able to determine a reasonable amount to factor in.

6. Leasing is financing the depreciation of the car! I know this has been said before, but it is so important to understand this. There is no need to have a residual value at the end of the lease that is below what you think the value of the car is going to be at the end of the term. Your payment should be the lowest you can get while keeping the residual value high or above the estimated value of the car at the end of the lease. This seems the opposite of what you would thing, right? Well, if your residual value is higher than the car is worth at the end of the lease, then you are in effect renting the car for less while you are driving it which is the object of a lease (very important: remember all you checks in step 1 and 2, it is you check that they have applied all amounts).

7. In most cars, 36-month leases are optimal. Why? It has to do with depreciation. Any longer and your paying for a steeper rate of decline and it does not make sense to do that.

8. Never do off – term loans (i.e. 39-months, 52-months, etc)! These are designed to build in better profit margins while looking better to the consumer. I have never seen one in that is better then a traditional term loan. They might be out there, but if you go down that path be sure you know how to fully calculate everything on the loan because if you don’t you are probably better off pulling all your cash out of your wallet, handing it to the dealer, and then leaving.

Before you lease always know at least how to do the tips above and please do more homework. Leases are very easy for dealers to make incentives and down payments disappear. I firmly believe, that with out leasing the car dealers would be in far worse condition profit wise today.

Be wise, do you homework and happy leasing! Send questions out to the public in the comments!

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