Auto Loan Information

By Keith Longmire

In the past choosing how to finance your new car was pretty easy - you could take out a personal loan or you could take whatever finance package the dealer offered. Now things are different. There are dozens of ways in which you can finance your purchase. One of the most popular is to take out an auto lease deal.

What are Auto Leases?

An auto lease is effectively a long-term rental agreement - terms typically start at 24 months with 36 and 48 months much more common. Auto lease agreements do have a few twists to watch out for though.

With an auto lease you never own the car. The lease company purchases the vehicle. You lease it from the leasing company. At the end of the lease agreement you simply return the vehicle. As long as the vehicle is in good condition and hasn’t exceeded your mileage limits that’s all there is to it.

As the lease company gets the car back at the end of the lease they will be able to sell it at the pervading market value. The charges to you are based on the difference in purchase price and this residual value. Lease companies pay very close attention to the prices for second hand vehicles to ensure that this residual value is as accurate as possible.

How do Auto Leases Work?

So, suppose you find a car for $20,000 purchase price. The lease company does some sums and tells you that if you take out a 3 year deal with a 12,000 mile per annum mileage limit they will guarantee a residual value of $8,000. The net cost to the auto leasing company is $12,000 plus administration charges (setting up the deal and selling the car at the end) and finance charges.

As you are only paying finance charges on part of the value of the car ($12,000+costs in the above example) your monthly payments are lower. Even better, as the auto lease company owns the car you don’t have to pay a large deposit.

Low Deposit - Low Monthly Payments

The result is that you can drive a new auto for low upfront cost and relatively low monthly payments. The downside is that you never own the vehicle and may have nothing to show for all your payments at the end of the agreement.

What Happens at the End of the Auto Lease

Most lease packages include an option to purchase at the end of the deal. Residual values are normally pretty conservative. So, provided you return the auto in good condition and inside your mileage limits the odds are that it will be worth more than the pre-defined residual value. You than have 3 options:

1. You can purchase the vehicle for the pre-defined residual value
2. You can trade the vehicle in and use the difference between the current market value and the residual value as the deposit on your next lease
3. You can hand the car back and walk away.

Auto lease companies claim that most people trade in and use the difference to pay their next deposit. Many auto leasers do this time after time going from one lease deal to the next. They like driving new cars and they don’t care that they never own the car at the end of the deal.

Auto Leases - All Good News - Not Quite

Just in case this all makes auto leasing look very attractive you should note that in the long run leasing almost always will be a bit more expensive than buying through an auto loan. While lease companies have to compete to keep their prices attractive they still do have to make money. In the end auto lease companies have to pay enough to make the auto leasing business profitable.

Auto leasing deals are not for everyone. To manage their risks auto leasing companies put tight constraints on the deals they offer. Leases are for fixed period and it is practically impossible to exit a lease early. Calculation of residual values is highly mileage dependent so you may find any excess mileage payments are expensive. Nevertheless, if you want to drive a new car, can guarantee to keep the vehicle for the full term of the lease, and can stick to the mileage limits in your agreement, leasing can be a great choice.