Maybe You Should Lease Your Next Car
In a previous life, I worked for quite a few years as a senior manager at a couple of large auto finance companies. At one of the companies, we offered both open-end (commercial) and closed-end (consumer) leases on cars and trucks, and at the other, we offered consumer vehicle loans and consumer vehicle leases, with the portfolio split pretty evenly between the two finance products. We weren’t as large as the biggest auto finance units, but we were pretty big for the time, with almost a million units in the portfolio.
It was readily apparent to me during those stints that there were many people who would have been better off leasing their vehicle and were instead getting car loans. The reason for this hesitation on the part of consumers is no mystery; there were some serious abuses of consumers through vehicle leasing in the early 90’s because the disclosure requirements on lease contracts then were laughably weak. Many auto dealers and their F&I managers were just crushing people with lease terms that the consumer wasn’t even aware of, and usually did not find out about until it was much too late. These poor people were just getting put to sleep in the F&I office on car leases. It was really, really bad and it did not escape the notice of consumer groups and media outlets. Horror stories of people getting $1000 for their $5000 trade-in, having to pay mileage penalties of several thousand dollars upon lease termination, outlandish early termination fees, and never even knowing about it until the moment the pain was delivered – all this and more filled the airwaves and the newspapers. Consumers would sign up because the payments were lower than their loan payments would have been, never realizing that the payments should have been much, much lower. They couldn’t know the terms of the lease because the terms weren’t on the lease agreement. Very little was on the lease agreement except the vehicle description, the lease term, and the payment. And very quickly leasing developed a reputation as something you wanted to stay away from if you had any brains at all.
But, as usually happens, all of this negative press forced positive change. New regulatory requirements starting in 1995 forced vehicle lessors (the vehicle leasing companies) to disclose a great deal more information, and leasing then became fairly popular, especially since the new lease requirements happened about the same time that the average consumer was starting to look at SUVs with considerable ardor. Those SUVs were a lot more expensive than what most consumers had before, and leasing was a great way to maintain the same monthly payment and still drive something with a much pricier MSRP. Additionally, when the SUV craze first started, the manufacturers (the Big Three) couldn’t make them fast enough. Residuals were though the roof. As an example, I remember we were writing leases on Ford Explorer SUVs at the end of 1997 with 71% residuals after 36 months. Compare that to the current residual of 40% after 36 months on a 2006 Ford Explorer. This made monthly lease payments on a $35,000 SUV cheaper than lease payments on most $25,000 cars. And, of course, much, much cheaper than if you had loan payments on the same vehicle. Yeah, it was crazy, but every lessor was doing it, and if they didn’t, they could get any lease business from the dealerships. Leasing rose to 26% of all consumer vehicle financing. But, even with leasing deals that were phenomenally good for consumers, a major part of the consumer market still stayed away because their perception of leasing (read: satanic and evil) had not caught up with the reality that leasing was a pretty good deal for the consumer in many instances. By the way, leasing is still a pretty good deal for many consumers, including a sizable segment that never consider leasing as an option (more on that later).
Now, the next part of the story, the part that will tell you why there are not as many auto leasing companies as there used to be. In a matter of a couple of years, everyone started to figure out that the residuals on SUVs were way too high. Unfortunately, for the lessors, this was two years into a lease they already written for a term of 3 or 4 or 5 years. Consumers that had the leases figured out the same thing about the residual values, and didn’t exercise the option to purchase their leased vehicle at the end of the lease term, and instead, just gave back the car to the lessor when their lease was up. Suddenly the lessors were getting swamped with end-of-lease vehicles, which all had to be sold by them somehow. Since the banks and finance companies didn’t have huge used-car lots (and the requisite dealer’s license) scattered all of the United States, those returned cars, which by this time were mostly SUVs, had to go to auction. So many of the same thing showing up at the wholesale auto auctions just depressed the values of those used vehicles even further, and caused huge shortfalls from the original stated residuals on these vehicles, which in turn, wiped out any profit the lessors had made on the front end. Lessors, whether they were banks or finance companies, were sustaining massive losses, and they got out of the leasing business as quickly as possible. So, by 1999 or 2000, most lending organizations also believed the auto leasing was the work of the devil, and wanted nothing to do with it. In fact, in 2006, this hangover still hasn’t gone away for a lot of auto finance organizations. They still want nothing to do with leasing.
The combination of most consumers still being scared of auto leasing as a result of the awful things that happened in the early 90’s, and most finance organizations also being scared of leasing as a result of what happened to them in the late 90’s, saw consumer vehicle leasing drop to 14% of the market in 2003. Most consumers were wary of leasing, and if they weren’t, their choices of leasing products were limited, since so many companies had exited the business.
So, here we are at the end of 2006, and leasing has slowly climbed back up to 17.7% of the consumer auto finance market, which still isn’t much. There are still not too many lessors, but the number is increasing steadily. I am certain you enjoyed the short recent history of leasing that I delineated for you, but like most people, you are ruled by your self-interests. And your self-interests want to know, “Is leasing a better deal for me?”
The answer is, “all depends”. But here’s a start on whittling down the gray areas. These are people that unequivocally should NOT lease:
v If you keep your cars forever
v If you put lots of annual miles (30,000+) on your cars
v If you typically beat the living daylights out the vehicles you own
v If you want a new car every 12 months (or less)
v If you just can’t live with the whole concept of renting your daily transportation through a multi-year contract
Okay, so what sort of consumers should consider leasing their vehicles? Here are the people who should think about leasing:
v If you like a new car every two, three or four years and you cannot or will not pay cash for the car
v If you want/need a vehicle that you cannot otherwise afford the monthly loan payments (the lease payments will probably be quite a bit lower)
v If you typically put anywhere from 10,000 to 20,000 miles a year on your car
v If you take care of the vehicle you drive – both its appearance and mechanical condition
v If you have better than average credit – it takes a little higher FICO score to lease a vehicle than to get a loan
v If you hate hassling with whole trade-in/selling it yourself conundrum when you want another car (at the end of a lease you can just turn the car back to the lessor, and you’re done with it)
As I mentioned before, there is another sizable segment of consumers that really should take a hard look at leasing, but typically don’t. This consumer currently gets a 60-month, 72-month, or even an 84-month loan contract now on their new cars. The most popular auto loan term in the United States now is 72-78 months. The reason they get such a long term on their loan contract is to be able to afford the monthly payments. So, this average consumer (let’s call him Jimmy) gets a 72-month installment loan on a new 2007 Infiniti G35 Coupe. No problem if Jimmy loves the G35 for the next, say, 72 months (6 years). Some people see these extended-term loans to the end. But what if Jimmy gets his head turned by some new sheet metal 2 years from now? Or three years from now? Because it’s on a 72-month contract, it’s going to be a long time before Jimmy owes less on that G35 than it’s worth, so if he wants to get out early, he’s going to have to take some pain. Maybe a lot of pain. And if gas prices go up again, and more and more people want cars that don’t consume much gas, or, run on diesel, or are hybrids, or whatever, two or three years from now, that just makes the pain that much worse. Or, Jimmy’s financial situation could change in the next six years, and the monthly payment is no longer affordable. Same result as Jimmy getting his head turned by an exciting new vehicle, that is, lots of monetary pain if you want to make a change. You have probably heard people at car dealerships refer to Jimmy’s hypothetical situation as “being upside down”.
Unfortunately, Jimmy’s hypothetical situation is completely real for a lot of people. I have seen an awful lot of borrowers get as many as three or four 72-month loans in a 10 year period. They keep getting these long loans and cycling out of them early. Maybe they intend at the time of the loan to keep the vehicle until the end of the loan term or maybe they know full well they’re not going to keep it that long, but they need the lower payments regardless, so they keep getting these extended loans. They add the amount owed (the amount they’re upside-down) on their last 72-month to the new 72-month loan and away they go. Just as an aside, this all obviously gets even uglier when people have 84-month loan contracts. These are people that should be leasing their vehicles. They can get a 36-month or a 48-month lease and considerably cut down the window of possibly being upside-down in their current vehicle.
Now, when I used to ask serial “early-term” borrowers like Jimmy in consumer clinics why they don’t just lease for a shorter term and thereby decrease considerably their chances of being upside-down next time they want a new car, this was the answer I invariably got: “But then I wouldn’t own my car. I don’t want to lease my car, I want to own it”. When my staff and I would point out to Jimmy that he never really owned his car on the loan agreement until he paid it off anyway, and that he would trade it in way before he got close to paying it off, he would say, ” Yeah, but with a lease, I wouldn’t have any equity in my trade”. So, we would do the math for Jimmy and show him that he really didn’t ever get a chance to build up equity, or, if he did, that it still didn’t equal the monthly savings he could have realized on a lease for the same vehicle, he would think about that for a minute, and then say, “Well, I just don’t want to lease”.
What can you do with someone like Jimmy? Nothing, really. He just doesn’t want to change. Hey, that’s his prerogative. And, believe me; you would be astounded at how many people (millions, actually) there are just like Jimmy. But, if your borrowing behavior resembles Jimmy’s and you are open to another way of financing the car in your driveway, you might want to look at leasing. If you decide you want another car 27 months into a 36 month lease, you only have another 9 months of patience to go. Or, if your lease payout is close enough to the actual residual value at that moment, you could exercise the early termination clause of your lease agreement, pay the early termination fee (usually the equivalent of one or two lease payments), turn the car back in to the lessor, and get your wonderful new wheels. Did I mention the payments are usually lower on a lease, by the way? If you decide you want new wheels 27 months into a 72 month loan, then it’s asking an awful lot to have someone wait another 3 and 1/2 years. That’s a lot of patience to exhibit. Or, you trade the car in and take the negative equity on the chin, but, that’s never very pleasant at the dealership, either emotionally or financially.
Now, let’s talk a little bit about how to lease a car without looking like a dope, or even worse, feeling like a dope after your friend Sally or Herb or Althea reads your lease agreement after the fact and announces, “I think you got taken”. This is by no means an all-inclusive list of things to cognizant of; it’s not Leasing 101, but rather just the things people usually get hung up on when they haven’t leased before.
First of all, if you are not very familiar with the legal language of a vehicle leasing agreement, then go with a well-known lessor. It is probably prudent on your behalf to stay away from local vehicle lease companies called “Best Leasing”, “Platinum Leasing”, Bob’s Lawn Car and Auto Leasing”, and the like. It’s not that all the small leasing companies are unscrupulous, it’s just that some of them are, and I can’t tell you which ones are bad or good where you live. Whereas, the big lessors have very similar contracts with very similar terms, none of which are onerous for consumers, and anything bad that happens vis-à-vis these contracts happens at the dealership, not in the offices of the lessor. As I mentioned earlier, the amount of disclosure currently provided by large lessors is considerable.
Second, capitalization cost (cap cost) is how much the vehicle is being sold to the leasing company (lessor) for by the dealer. The dealer sells the car to the lessor, who then leases it to you. So, any cap cost reduction should show up as a subtraction from that price. Here’s an example: $1000 discount off sticker by the dealer and $2000 down from you means the cap cost goes down by $3000. If you trade a car in, whatever the trade is worth is also a cap cost reduction. When you see leasing ads with really low payments that require $5000 down, it is referred to as a $5000 cap cost reduction. Dealers do not lease cars, leasing companies lease cars. Dealers, just like when you get a loan, have a tremendous interest in making the price of that car as high as possible when it gets sold to the leasing company. That’s how they make some of their money on the transaction. The lessor doesn’t care at all how low the cap cost is; only if it’s too high. So, you still need to nail down the price of the car with the dealer. It will make a difference in your lease payments.
Third, mileage limits have tripped up an awful lot of people on leases. If you see a really low leasing payment, look at the annual mileage limits. If the annual mileage limit is 8000 miles a year and you put 15,000 miles a year on your car, just like clockwork, then that just isn’t going to work for you. Get a lease with realistic mileage limits for you personally. If the salesman or F&I manager says that 10,000 miles a year is their standard mileage allowance, and you need 15,000 miles a year, then ask how much the payment goes up with a 15,000 mile a year allowance. They (and the lessor) can easily do this, and then you can make an informed decision. DO NOT, I repeat, do not get a lease with a lower annual mileage amount than you need. It will be far more expensive to pay the excess mileage penalties at the end of the lease than for you to pay for the miles upfront when you hammer out the lease agreement.
Fourth, always ask about lease deals offered by the captive lease company, because these are sometimes great deals. Here’s an example: As I write this, Chrysler is heavily subventing their leases in the U.S., and this means that it is a very good time indeed to lease a 2006 Chrysler Corporation product. What is subvention, you might ask quizzically? When lessors subvent a lease, they typically artificially bump up the residual value of the vehicle leased, or, lower the lease finance rates, or, lower the FICO credit scores needed in order to be approved for the lease. Faced with ridiculous amounts of unsold inventory, Chrysler is employing all three methods of subvention simultaneously on their captive (through Chrysler Finance) leases, making a lease on a new 2006 Dodge, Jeep, or Chrysler very inexpensive. If you are in the market for a Chrysler product, and also want to lease, this is very much a magic moment in time. This sort of thing happens with the captive lease companies with regularity, not matter which brand you’re shopping, but particularly with the high-line brands. The luxury brands would much rather offer you a subvented lease where you can’t see all the discounting that takes place as opposed to giving you a $5000 rebate. Rebates on cars tend to diminish the value of the car in the eyes of the public since they (the public) assume you must be selling distressed merchandise if you have to pay someone to buy it. Car makers don’t want to devalue their brands if they can help it. Look at all the damage it’s done to the domestic brands over the years. It’s a lot better to offer a subvented lease, which, even though the discount may add up to the same $5000, the discounting is invisible to the consumer. When the consumer asks, “Why is this payment so low?” the salesman can say, “Well, leases work off of residuals. The higher the residual, the lower the lease payment. Our cars retain such an astounding amount of their residual value after three years that it makes the lease payments really low.” And the customer says, “Oh, okay. That makes sense. I’m glad I’m getting a car that holds its value so well”.
Lastly, look at the various fees in the agreement. There will be fees for early termination, disposition fees, excessive wear and tear, etc. The more expensive cars and the captive lessors may have a whole section of the lease agreement devoted to excessive wear and tear. Make sure you know what each fee is for, and when it would apply. Almost every contract in the United States offers GAP insurance free, but if there is a fee for it, it should be a small fee. If it’s not, go with another lessor because GAP is a necessity for you as the lessee.
That’s it, that’s all the advice you get today. My altruistic well is dry for the moment.
Just to be clear, I’m not advocating that everyone should lease their vehicles, or even that most people should lease. What I’m saying is that there are millions of people that currently get auto loans that would probably be better off with a lease instead. You may or may not be one of those people, but this is just a heads-up that if think you might be in that group; it’s worth checking out a potential lease the next time you get a new car.