What is a Lease?
Leasing is a car financing option that makes a car affordable for the buyer. With sky-high prices of modern vehicles and peaking interest rates on bank loans, the ‘new car experience’ had become a long-lost dream for many who lived on small to moderate incomes.
What exactly does a lease do? A lease makes the usage of a car affordable for you. With such an agreement, all you have to do is make the monthly payments that comprise of the actual cost of the vehicle, with small amounts of interest payments for the duration of the usage of the car. Doing so gives you the right to use the car on a daily basis; however, ownership is not transferred to the driver.
Thinking of leasing as renting an apartment in Toronto wouldn’t be incorrect. In fact, the two processes are quite similar. As you keep paying for rent every month, you use the apartment and its facilities till you decide to move out. Similarly, when the leasing period is over, the car is returned to the bank or the company that initiated the lease.
There are many prominent advantages of leasing, the top one being no worries regarding maintenance. The car you lease will usually come with a warranty to ensure good condition. Hence, for the duration that you use it, if you don’t damage it significantly, maintenance and wear and tear fixing falls on the leasing company and is covered within the monthly payment.
Who provides the lease?
Before you think about getting into a lease agreement, it is important to identify the various parties involved. It is a common misunderstanding among people that the Car Dealer issues the lease and monthly payments go to him. In fact, the car dealer only shows you the right car. All other leasing business is done by, first- a leasing company, second-the bank, or third, the car manufacturer.
Car manufacturers often have their own leasing plans such as Ford Motor Credit. These plans offer very competitive leasing rates that help an average Canadian lease a car of his choice. From the company’s perspective, these plans are a sure shot way to sell more and more vehicles to every household by making them affordable.
There are several clauses that are part of the leasing agreement. One of these terms states that when you approach a car dealer for a vehicle on a lease plan, the dealer actually sells the car to the leasing company, which in turn leases it out to you. While the leasing company receives regular monthly payments from you, the car dealer is given a commission by the leasing company as a fee for making the deal.
Because leasing is a full-fledged business, it helps to understand a few terms that are particularly relevant to this mode of financing. Before approaching a car dealer or a leasing company, familiarize yourself with these terms so that you understand the agreement and are in a position to make a decision.
- Capitalized Cost: Also known as Cap Cost, the Capitalized Cost is the purchase price of the vehicle. The Capitalized Cost is different from the Manufacturer’s Suggested Retail Price because as a customer, you will always negotiate and try to find a Capitalized Cost that is as low as possible. Hence, the MSRP is not always the price for which the car is sold; instead, it is given as a rough estimate of its value. The difference between the MSRP and the Cap Cost is called Cap Cost Reduction. The lower the Capitalized Cost, the lower the monthly lease payment that you have to make.
- Depreciation: Depreciation is a deciding factor when the leasing amount is decided. What really is depreciation? For as long as a car exists in operational form, its value keeps decreasing. This decrease is called depreciation. Depreciation forms a huge chunk of the leasing payments because it is how the leasing company makes its earnings. In simple words, the company wants you to pay for the difference in what the car was worth when you leased it and what it is worth now.
- Residual Value: Residual Value is the value/price of the vehicle at the end of the leasing period. Companies that give out leases need to know the residual value of the car so that they can determine the monthly payments that you will pay. Remember, the higher the residual value of the vehicle, the lower the lease payments. Once the residual value is found using industry standards, the depreciation on the vehicle can be determined.
- Interest Rate (Money Factor): Interest Rate and Money Factor are quite similar. While the former is represented as a percentage, i.e. 6%, the latter is shown as a series of decimal points, i.e. 0.00250, which is 6% divided by a factor of 2400. Money factor and interest rates are an important part of the leasing agreement because they are often compared to the rates on buying a new car.
- Term: Term is the duration for which the lease will last. Typically, you will hear terms like 24 months, 36 months, 48 months, and so on. Apart from these, midterm durations like 39 months and 42 months are also available. The Term of a leasing contract can then be divided into long term and short term. Depending on the preferences of a customer, either one can be chosen.
- Taxes: Taxes in the lease agreement are determined according to state laws. Many other times, they are calculated according to the overall cost of the vehicle or the depreciation value. They have to be paid on a monthly basis.