People love low monthly payments. In order to move vehicles, often times, manufacturers will subsidize leasing, either directly through lease cash or rebates or by buying down the lease rate, or indirectly, by working with a captive lender to increase residual value. Direct subsidies pay down the principle balance, where increased residual makes the depreciation lower. Often times, you'll find advertisements for loss leader leases, where there is one stripped out base model in stock for a low lease payment that they hope to upsell you to a better car on.
That said, there are often deals to be had on leases. If you've made the decision that buying a new car is what you want, leasing can be a great way to do so. Or if you aren't sure you want to keep this car for a long period of time, leasing gives you a defined way to get out of it at a particular juncture, as long as you keep the car in reasonably good shape. Here are the typical cases where leasing makes a lot of sense:
There are cases where leasing does NOT make sense. These are very common and people end up hating their lease and not being able to do much about it.
One common mistake people make is trying to put a large amount of money down on a lease to reduce the amount of interest you are paying. Remember that interest is charged on the entire balance of the lease, which is the total value of the car, not the just the depreciation. This is why it is comparable to financing the entire amount of the car. You only reduce the balance slightly by putting money down, so the difference it makes is relatively small. The biggest danger of this is that if the car gets totaled after an accident, the insurance company will pay off the leaser first. The danger is that you might not get your down payment back - depending on how much the car is worth at the time of accident and might need to lease something else without getting your huge down payment back. Putting down a little bit of money won't hurt but I definitely wouldn't put down much.
Assuming you fall into a category where leasing makes sense, here are some helpful terms when thinking about a lease:
Glossary of terms
The above is all you need to know. Typically, money factors are 1-2% higher than interest rates, unless they are subsidized.
We'll use a 2011 BMW M3 convertible as an example.
MSRP: $81375 (including destination charge)
Invoice : $74980
Gross Capitalized Cost: (or Gross Cap Cost) $74730 - (invoice + $200 MACO & $400 Training + $350 transportation fee (dealer trade) - $1000 rebate for Drive for USA... a BMW specific program. (MACO is an advertising fee levied on the dealers regionally, by BMW USA, training is another fee. MACO is residualized, training is not.)
Net Capitalized Cost: (or Net Cap Cost) $74730 - since no additional cap reduction was put down, gross and net are the same. Remember that anything you put down gets taxed in California as well.
Residual: $49638.75 or 61% of the MSRP
36 months/10k miles per year: 61%
36 months/12k miles per year: 60%
36 months/15k miles per year: 58%
These values legitimately vary monthly - it is often worth it to ask about other financing periods. Normally each month is about 1% and any less than that is good.
Money Factor : 0.00060 or 1.44%
Depreciation : $74730 - $49638.75 = $26091.25 (Simply the Net Cap cost
Finance fee : ($74730 + $49638.75) * .00060 = $75.22
Total Monthly Payment : (Total depreciation - $26091.25/36) = $724.76 + (Finance Fee - $75.22) = $799.78 * (local sales tax - 8.25% in this case - 1.0825% = $865.98
Driveoff: $865.98 + $925 acq fee + $900 reg and DMV fees = $2690
One thing to look out for in leasing is that most of the time, ads for leases will not include taxes or fees, which as you can see above, can add up to a significant amount, either raising the drive off or payment or both. The fees are legitimate, but it makes it hard to compare ads with what you actually paid. Often times, the ads will omit: Acquisition fee, DMV fees, including Vehicle License Fees, processing fees, taxes on cap reduction, etc. An easy rule of thumb for DMV is count on DMV fees being about 1.2-1.5% of the MSRP of the car.
This payment is far less than buying the car and financing the whole thing. Even at 84 months, which is typically the maximum term to finance the car, you're looking at $1120.92 a month, and at the end of the 36 months, you'd still owe $50,846.31 (or about the residual value) since you paid the sales tax on the entire $81375, rather than on the 39% of the car you used during the 3 years you had it. In this case, leasing makes a lot of sense, because of the extremely low money factor and the high residual value. That said, more than likely, buying a 2-3 year old M3 convertible would make even more sense if you were going to keep the car a long time.
I had a Google Spreadsheet that I used to calculate this, but it kept breaking on my phone when I wanted to change values. Now, I use Leasematic as a convenient calculator to check out leases. http://leasematic.com/ It can be a little tricky to use, you always want to capitalize all your fees, and to tax your rebates in CA. Also, in California, you do NOT want to cap Sales tax. But, it can calculate what a down payment would do to your monthly, and what Multiple Security Deposits will do to your payment. You can also calculate trade ins, but be very careful with trade ins - remember that if you owe more than your trade is worth and you want to pay off a trade as part of a lease, you will get taxed on it like a cap reduction if you do it as part of the lease. Always better to take care of a trade separately, if you can.
Hope this has been a useful lesson!
Silicon Valley Dad, who loves cars, cooking, clothes and cameras