Auto Leasing Do's and Don'ts

provided by

Aside from having a new car every few years, a major attraction to leasing is that "you get more car for the same monthly payments," says Robert Haber, a New York City art dealer who is leasing his Lexus RX 330 SUV.

These pluses will seem convincing to many new car shoppers, but to lease successfully, you need to understand the transaction. The concept is simple, but the execution is often highly complicated. When you lease, you pay, in effect, for the loss in value of a vehicle for the three or four years you are leasing it, plus interest on that amount.

Dealers will want to talk only about monthly payments, but to lower those payments you need to understand all the moving parts.

How Leases Work

Leasing comes with its own jargon. The most important factor in determining payments is the difference between the starting cost, known as the capitalized cost, and the estimated value at the end of the lease, called residual value. Auto brands that have high resale value, such as Mercedes-Benz, are good candidates for leasing.

Usually the best available lease deal will be the one offered by the manufacturer's captive finance subsidiary (see definition below). They often offer subvented, or manufacturer subsidized, leases, a promotional effort designed to help move certain vehicles. These deals are most common for luxury brands, and typically the residual value will be fixed, as will the interest rate. Thus your only weapon to lower payments is to negotiate down the capitalized cost — just as you would try to lower the purchase price if you were buying the car instead.

Leasing has its pitfalls, as well.

Do’s and Don’ts

• Don't sign a lease longer than the warranty on the car. You don't want to be paying for repairs on a car you don't even own. On Ford, General Motors and DaimlerChrysler cars, three-year warranties would call for no longer than three-year leases. 
• Don't sign a lease with mileage limitations that are unrealistically low for your driving habits. Excess mileage costs at the end of the lease can be very expensive. You will likely save money by negotiating up front for a limit higher than the typical 12,000 miles a year, if you think you will need it.
• Do protect yourself against theft or serious collision loss early in the lease. If the vehicle is stolen or totaled, your insurance will pay only the depreciated market value of the car at that time, which may be less than the total you owe on your lease. So-called "gap insurance" will pay you the difference between your insurance settlement and the total amount you still owe on the lease. Most leasing companies offer this coverage, and it is one of the few add-ons that makes sense to accept. Gap insurance as part of the lease usually won't cost you any more than getting it from your insurance agent, and is more convenient.
• Do brush up on leasing jargon, so you can be a savvy negotiator.

Leasing Terms to Know

Capitalized Cost: The lease transaction's equivalent of the selling price. Payments are determined largely by the difference between the capitalized cost and the residual value (see below).

Capitalized Cost Reduction: Jargon for down payment in a lease transaction. You can use it as a way to reduce payments if, say, you have the proceeds from selling your old car, or if you are trading in your old car.

Excess Mileage Charge: A penalty for driving more than the mileage allowance in the lease — typically around 12,000 miles a year. To avoid this penalty, make sure your lease has a mileage allowance matching your driving habits.

Captive Finance Companies: These subsidiaries of major auto companies, such as Ford Motor Credit and General Motors Acceptance Corp., make auto loans on the companies' brands. Often they have better rates than those offered by the dealership itself.

Subvented Leases: Subsidized by the manufacturer, these leases are generally designed as promotional efforts to help move vehicles. Often, these can be one of the best deals for the consumer considering leasing as an option.

Residual Value: What the vehicle will be worth at the end of the lease. It may or may not match true estimates of the used car value at that point. When a manufacturer wants to promote leasing of a certain model, it will lower payments by artificially boosting the residual value.

When Does it Make Sense to Lease Instead of Buy?

A choice to lease or buy with a loan is largely one of personal preference and driving habits. If you typically trade for a new car every four years or less, drive less than 12,000 miles a year and keep your vehicle in good condition, you may be a good leasing candidate.

Especially among luxury brands, the best deals are often ones from the company's own finance arm. Because they prefer promotional leases to giving rebates, companies such as BMW, Lexus and Mercedes-Benz often offer leases that have low interest rates, above-market residual values or both. The result is lower monthly payments.

Copyright © 2007 Forbes.com LLC