How do I know if the residual value is correct?

It's an educated guess, nobody knows for sure. Leasing companies allow a range of residual value percentages. Let's say 50 to 60% for a particular model on a 3 year lease. Dealers will always choose the highest percentage possible because it lowers the monthly payment. Lessees like low monthly payments. The dealer has no risk because the leasing company is guaranteeing the residual value. Manufacturer's leasing companies usually provide the highest residual values on the market.

Should I pay a down payment on my lease?

Mathematically speaking, the higher your down payment, the less interest you will pay. However, there are two situations where you shouldn't put any money down.

1. There aren't much savings to be had if the lease interest rate is very low or 0%, so use the money for investing or paying down other high interest rate debts.
2. Even though you have money to put down, don't do it if you can't afford to do it every time you lease a vehicle. Otherwise, you will lease a more expensive vehicle than you can really afford. The next lease, you won't have any money to put down, which means you can only lease a much less expensive vehicle. If you are on a tight budget and you want to keep leasing affordable in the long run, lease with $0 down.

I've always purchased my vehicles and kept them a long time, should I switch to leasing?

No. The least expensive way to drive a vehicle is to buy a quality vehicle, maintain it well, and keep it for a long time (10 years or more). While this doesn't appeal to everyone, if it works for you, stick with it. Leasing hasn't changed the rules when it comes to common sense. It will never be cheaper to buy/lease a new vehicle every 3 years rather than keeping one vehicle for 10 or 12 years. In the first 3 to 4 years a vehicle depreciates 50%. If you keep the vehicle for another 8 years and then scrap it, it will depreciate the remaining 50%. Depreciation is the largest vehicle cost, not maintenance and repairs. If you can reduce that cost the savings are tremendous.

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Leasing is just another way to pay for something. Nothing more, nothing less. Unfortunately those who developed leasing decided to introduce new terms, definitions and complexities that confuse just about everybody. To help you learn the lingo read below.

Glossary of Terms - Leases

Acquisition Fee - A $300 to $400 fee to establish and administer a lease. These hidden fees were tacked on to most leases without the consumer's knowledge or agreement. In March 1996, six Canadian residents filed a complaint under the Competition Act for misleading the public. Although the investigation found that these fees did exist and were not disclosed in lease transactions they concluded the dollar amount was not significant. Three to four hundred dollars per lease not significant?

Annual Percentage Rate (APR) - Whether you lease or buy, you must know the interest rate you are being charged. This was one of the biggest problems with leasing in the past. Today, many dealerships are voluntarily advertising/providing the lease interest rate to consumers. However, there is still no legal requirement that they do so. Joint Federal/Provincial legislation has still not been passed (as of 2002). But even then, it will only apply to retail consumer leases not commercial leases.

Buyback - See residual value

Capitalized Cost - This is the selling price that the lease is based on. This is the equivalent of negotiating a purchase price when you buy a car. The lower this figure is, the better the lease deal will be. This must be written in your contract, no figure, don't lease.

Capitalized Cost Reduction - See down payment

Closed-End Lease - Unless you are very experienced at leasing this is the only kind of lease you should consider. A closed-end lease means the leasing company guarantees the residual value. You don't have to make up any difference between the wholesale value and the residual value if the leasing company overestimated the residual value. Also known as a "walk away" lease.

Down Payment - An amount that is paid up front. There are three components to the down payment when leasing. Part one is the amount paid towards the lease. Part two are the charges you must pay up front: freight and PDI, air tax, gas tax, admin fees, etc. Part three is the first lease payment and security deposit. Add sales tax to the total and you will know how large a cheque to write before you can drive off the lot.

Effective Interest Rate (EIR) - If you could pay back $1200 in interest a year from now or $100 a month for the next 12 months, which would you choose? Well, if it costs you $1200 either way why not keep the money in your possession for as long as possible. Effective interest rates take this into account. The effective interest rate when $1200 is paid after a year would be 12.00%. The effective interest rate when $1200 is paid $100 a month is 12.68%. The CarCalculator does not use EIRs.

Early Termination Penalty - When you first drive off the lot the vehicle is worth less than what you still owe on the lease. Usually leasing companies will take the number of payments left, multiply by the months left in the lease, add the residual value, and possibly a further penalty for early termination. That's how much you still owe on the lease. They then subtract the wholesale value of the vehicle. The balance, which is almost always negative, is what it will cost to terminate the lease.

GAP insurance - Guaranteed Asset Protection insurance pays the difference between what your car is worth and what you still owe the leasing company if the vehicle is written-off or stolen. See Early Termination Penalty for more information.

Lease Term - The number of months you have agreed to lease a vehicle for.

Lessee - You, the one leasing the vehicle.

Lessor - The dealer or company leasing you the vehicle.

Mileage Allowance - Most leases allow 18,000 to 24,000 kms per year. There is a penalty if you exceed the limit because the vehicle's residual value was estimated based on a certain number of kilometers per year. The penalty is a per kilometer fee. The fee is waived if you purchase the vehicle at the end of the lease. It is cheaper to purchase a greater kilometer allowance at the start of the lease, rather than paying the per kilometer fee at the end. Some leasing companies will reimburse you at the end of the lease if you purchased extra kilometers but didn't use them.

Money Factors - A money factor is a value which leasing companies use to calculate the interest portion of your payment. They first calculate the depreciation per month and then calculate the interest portion by using factors. i.e. 0.0050. It was developed to ensure that most consumers would have no clue how leases are calculated. There is no difference and no advantage to using money factors since they are derived from interest rates.

Monthly Payment - This is the amount you must pay on the lease every month.

Open-End Lease - Unless you are very experienced at leasing you shouldn't consider this kind of lease. Open-end means you guarantee the residual value. If the vehicle is worth less than the estimated wholesale value, you must buy the vehicle at the end of the lease or pay the shortfall in order to terminate the lease.

Payments in Advance - When you make payments, you can make your first payment immediately, like leasing, or a month from now like loans. The term "Payments in Advance" means your first payment is due immediately.

Payments in Arrears - When you make payments, you can make your first payment immediately, like leasing, or a month from now like loans. The term "Payments in Arrears" means your first payment is due one month from now.

Residual Value - This is the wholesale value that the leasing company estimates your vehicle will be worth at the end of the lease. It is an educated guess. There is no way to know for absolute sure what the vehicle will be worth. The residual value must be written in your contract, no figure, don't lease. Also known as buyback.

Rule of 78 - Most institutional lenders calculate the balance owing on a debt using the declining balance. That means each month the interest is calculated and any remainder reduces the principal. Most lessors and manufacturer's finance arms use the Rule of 78 instead. This formula uses fractions instead of calculating the balance owing using the declining balance. It will always cost you more to payoff your lease obligation under the Rule of 78 than under the declining balance method. The difference can be thousands.

Security Deposit - An amount paid up front and kept by the dealer until the end of the lease. Held in trust in case a payment is missed or there are penalties at the end of the lease.

Termination Fee - Many leasing companies will charge several hundred dollars if you don't want to purchase the vehicle at the end of the lease. This is suppose to cover the costs associated with accepting a vehicle back. This fee is illegal and you should refuse to pay it based on the fact that the fee raises the interest rate charged beyond what was on the original lease.

Wear and Tear (excess) - When you return your leased vehicle at the end of the lease you must pay to repair any excess wear and tear. Some lease contracts define wear and tear, some don't. Usually items such as upholstery tears, noticeable scratches, missing trim, bald tires, and any other excess wear and tear must be repaired and paid for by you. If you purchase the vehicle at the end of the lease you are not subject to this clause, but you will have to pay to certify the vehicle in order to transfer the ownership.

Zero Down - Some leases are advertised as zero down. Although they advertise zero down, they often want you to pay up front for freight and PDI, air tax, gas tax, and administration fees. That means it will usually cost you about $1,000 plus first payment, security deposit, and sales tax to start your lease. Not exactly zero down. Some leases roll all the extras into the lease. This is quite rare. In these cases, you will only pay first payment, security deposit, and sales tax to start your lease. Under this method you pay closer to zero, but it's still not zero.

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1. A senior citizen walks into a Chrysler dealer to trade-in his used car to purchase a newer used car. He is told that financing would not be approved. He is offered a lease on a new 95 Dodge Neon. Although the senior citizen is always interested in purchasing, without being alerted to the fact, he signs a contract to lease with no option to purchase. Total cost to drive a 95 Neon for 48 months $19,490.11. Senior citizen ends up losing his apartment and moving back with his daughter, Chrysler is suing senior citizen for $2,200.

2. A young man who had never purchased a new car before, went to his local GM dealer because an acquaintance worked there. He was negotiating the purchase of a 94 Chevrolet Cavalier Z24. He had negotiated a price of around $18,500 when the manager made the leasing pitch. He made the usual comments, like leasing is better than buying, our financing rate is much higher, and if you want the best deal, lease. The young man finally signed the lease and regretted it ever since. Purchase price used to calculate the lease $23,100. That's $4,500 + more than the last negotiated price. He ended up defaulting on his lease and is now being sued by the dealership, he is countersuing the dealer.

3. A young man with children decided to buy a Chrysler Grand Caravan. He knew a bit more about leasing than the average person, so he asked about money factors, and the purchase price used to calculate his lease. With those figures, and a friend who knew how to calculate leases, he was able to negotiate a very good deal. Later on, he decided to add a couple of options worth about $600. The dealer said this would be no problem. However, not only was the vehicle price $600 more, but now the down payment and the buyback changed. The result was that not only was he paying $600 for the extras, but also $1200 in new found profit for the dealer.

4. A baby boomer who wanted to live the lifestyle he couldn't afford, decided along with much encouragement from his wife and salesguy, to lease a fully loaded Dodge Caravan ES. It was an open-ended lease, which meant that if the vehicle wasn't worth at least $10,700 at termination, he would have to make up the difference. If it was worth more, he would get some money back from the vehicle. Minivans have been popular for many years. Knowing that his was all wheel drive, and in excellent shape, he took his van to several dealers and wholesalers for written quotes before the end of his lease. The quotes were all higher than $10,700 with the highest being $12,500. After he turned in the vehicle, the dealer let it sit on their lot for many months and finally bought it themselves for $9,600. The dealer said their bid was the highest they could get. Can you say 'conflict of interest'? In fact, they were nice enough to forget about the difference. The lessee sued in small claims court and won $2,000 plus costs. The judge said that they should have contacted the higher bidders and sold them the van. This was a first in Canada, and set a precedent that can be used in other cases.

Reference: Toronto Star, Wheels Section, Saturday, February 10, 1996.

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1. Leasing costs less than financing.
Truth: It costs less per month. However, the total cost is often higher than financing.

2. Lease payments are lower because dealers/leasing companies calculate their payments based on wholesale vehicle prices.
Truth: Lease payments are calculated using the same or higher vehicle price as cash sales or financing. Lease payments are lower because you are only paying off part of the vehicle, not the entire vehicle. However, at the end you own nothing.

3. Leasing costs less because you are only financing part of the vehicle.
Truth: There are no free lunches in life. You are paying off only part of the vehicle's value, but you pay interest on the full value of the vehicle. The leasing company bought the vehicle from the manufacturer and leased the vehicle to you. If they didn't charge interest on the full value of the vehicle they would be giving you a no interest loan on the residual value.

4. Shop around for the best monthly payment.
Truth: The monthly payment will tell you whether a lease is affordable, not whether it is a good value or not. If you want to get value, negotiate the lowest vehicle price (capital cost), lowest interest rate, and highest residual value possible. The down payment, term, and monthly payment, only affect affordability, not value.

5. You can afford to drive a better vehicle if you lease.
Truth: Yes you can, at least on your first lease. You can drive a better vehicle, but at the end of the lease you will have no equity in the vehicle and you will need another down payment. If you can't come up with another down payment you will have to lease a less expensive vehicle to maintain similar payments.

6. Leasing gives you more flexibility.
Truth: It gives you less flexibility than financing. A loan can be repaid at anytime with no penalties, leases cannot. Leases remain upside down for most, if not all of the term. This means you will always owe more on your lease than what the vehicle is worth. When you lease a vehicle, expect to keep the vehicle for the entire lease.

7. Leasing is better for businesses because they can write it off.
Truth: In most cases leasing and financing will produce similar deductions. For more info check Revenue Canada's guide for Business Income. It includes a chart for deductibility of leases and loans.

8. All leasing contracts are standardized.
Truth: Contracts are not standardized, each manufacturer's finance arm will have its own contract. Independent leasing companies or dealer owned lease companies will have completely different contracts. Anything can be in a lease contract, if you sign it, you agreed to it.

9. If you lease you pay less sales tax than a purchase.
Truth: You pay less sales tax if you lease the vehicle and don't buy it at the end of the lease. If you lease and buy the vehicle at the end of the lease, you will pay more sales tax than a purchase.

10. Leasing is more convenient.
Truth: Leasing can be more convenient for some individuals.

1. A company that needs to buy a fleet of vehicles and wants to spend as little as possible per month.
2. A self employed or commission sales person who needs new vehicles and/or expensive vehicles every few years.
3. A family who needs a large vehicle, but can only afford a small vehicle.
4. A consumer who understands exactly how leases work, the advantages and disadvantages, and then chooses a lease that meets their needs.

These are some of the conditions where leasing should be considered. It is not for everyone, if you don't do your homework be prepared to pay a bundle, and get very little in return.

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