hybrid car - How Does A Car Lease Work

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How Does A Car Lease Work?

When you lease a car, you're paying for its depreciation. Your monthly payments compensate the leasing company for the amount of value the vehicle loses throughout the duration of the contract. When your contract expires, you either return the car to the dealership or you purchase it.

There's an important distinction that a lot of people misunderstand. The dealership does not actually lease the car to you. They serve merely as a broker between you and the leasing company. For their trouble, they usually receive between 1% and 6% of the car's sale price. As you can imagine, these contracts are very profitable.

Depreciation Matters

Your monthly payments are calculated based upon how much a car is expected to depreciate over the contract's life. The more value it loses after 2 or 3 years, the higher your monthly payments will be. Here's an example: consider 2 vehicles, each worth $25,000 on the showroom floor. After 3 years, 1 car is worth $18,000 while the other is worth $14,000. In effect, the latter car lost more value. The car that is now worth $14,000 will have cost more to lease.

As a rule of thumb, vehicles which tend to lose less value during their first 2 or 3 years offer the best deals. It's also important to remember that foreign cars tend to suffer less depreciation than domestic cars.

Common Industry Terms

The contracts contain a lot of terms that may sound unfamiliar to you. If you're thinking about this type of arrangement, take the time to understand what each of the terms mean. The MSRP is the vehicle's sticker price and is used to determine its residual value. The residual value is how much the car is expected to be worth when you return it to the dealership.

Capitalized cost refers to the amount the dealership would have sold the car for through traditional financing. It's the initial price that will be used for the lease before deducting incentives, rebates, and any money that you're using as a down payment. Once those items have been deducted, the dealership arrives at a net capitalized cost. It's the net capitalized cost that is finally used when calculating your monthly payments.

The Life Of The Deal

If you're thinking of leasing a car, choose a model that won't suffer quick depreciation. Most vehicles lose nearly 50% of their value during their first 2 years. Remember, you're paying for that lost value in your monthly payments. You're also paying the dealership to broker the deal. Is leasing the right choice for you? Frankly, most people are probably better off buying a new or used car. That said, if you don't mind having to relinquish your vehicle every couple of years, it may be a great option.

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