Leasing

(a) What is leasing?

Car leasing was designed to make cars more affordable to consumers. As prices on cars have risen, the ability for consumers to afford a loan has decreased. Car leasing allows companies to reduce the monthly payments on a car by only requiring the buyer to pay for the cost of the car during the time they are using it. It’s very similar to renting – you don’t own anything, you are just paying for the right to use something. Unlike buying, you never actually own the vehicle and you have to return it to the leasing company at the end of the lease period. However, if you choose to own the vehicle you should pay the specified residual value at the end of the contract. The idea of leasing first became popular in the 1990′s when cars became too expensive to buy for many people. Leasing allows a person to drive a brand new car and make lower monthly payments, thus making the “new car experience” more accessible to more people.

(b) From whom do I lease?

When you write a lease, you are typically entering into an agreement with a leasing company or a bank that has a leasing program.

(c) Which Terms Do I need to be Familiar With?

There are 4 terms that you must be familiar with in order to understand how a lease works:

1. Capitalized Cost (“Cap Cost”): The capitalized cost is the purchase price of the vehicle. This will sometimes be referred to as “Cap Cost”.
2. Residual Value: The value of your car at the end of your lease is called the Residual Value. When creating your lease, the leasing company predicts how much the car will be worth at the end of your lease. The higher the projected residual at the end of your lease, the lower your monthly payment.
3. Interest Rate: Most people are familiar with an interest rate which is represented as a percentage (like 6.5% interest).
4. Term: The Term of the lease determines how long you will lease the car for. Typically you will hear of 36, 48, and 60-month term agreements. However lease Terms can run for as few as 12 months and as long as 84 months! There are even mid-year terms such as 39-month or 42-month terms. Customers have all kinds of reasons for choosing a short or long-term lease. Short-term lease customers typically want to change vehicles often and are willing to pay a slightly higher payment to have this option. Long-term lease customers are often willing to sign up for a long-term liability in exchange for a slightly lower lease payment.

(a) Understanding the Financing: One of the biggest decisions customers must make when financing a car is to lease or take on a loan. Let us first understand the differences and then discuss the benefits of both. The biggest mistake people make when comparing a lease versus a loan is thinking that depreciation – the largest cost of a monthly lease payment – is different. They are exactly the same in both cases. It is important to first understand depreciation. Whether you take on a loan or create a lease, your car is still going to depreciate at the same rate. This means that if your car is worth JOD 20,000 when you buy it, and then JOD 7,000 in 5 years, you still had to pay for the JOD 13,000 that was depreciated over the term. Here is where the difference between a loan and a lease really come into play. In a lease, you only pay the depreciation of the car throughout the term of the lease. In a loan, you pay the depreciation plus the additional principal that is required to pay the car of within the five year term (or whatever you choose). Do not forget that in both cases you are also paying the interest payments as well as taxes.

(b) How a Loan Works: In order to pay off a loan within a given period you need to divide the cost of the vehicle by only five years. In a lease you only pay the depreciation of the vehicle, not the entire price. Because you are paying the entire balance of the cost of the car in a loan, you own the car at the end of the term. This also causes the payments to be much higher in a loan than in a lease. Remember, even though you own the car at the end of a loan, you still lost the same amount of value in the vehicle as if you had leased it. The only reason you own the car at the end of a loan is because you paid the extra money each month to pay off the principal balance.

(c) Another Notable Difference: Much like a home mortgage, in a loan scenario, your monthly payment includes much more interest per payment at the beginning of the loan than at the end. A lease, however, charges the exact same amount of interest in each payment. Because of this, you may find yourself “upside down” in a loan for the first couple years because you are not paying off enough of the principal cost of the car during the beginning of the term. Loans are designed to pay lenders “up front” because you are not obligated to continue the loan through the entire term. Leases, on the other hand, require you to pay a fixed amount for a fixed period of time, and therefore leasing companies can charge customers in a different manner.

(d) How a Lease Works: At the end of a lease you do not own the car, but you also did not have to pay the extra money each month during the term of your lease. Keep in mind that you can purchase a vehicle at lease end if you really want to keep it. This can be done by paying the residual value previously set on the leasing contract. The difference between a loan and a lease really comes down to how you want to use the additional money. Do you want to invest it in your vehicle or do you want to invest it elsewhere