Last week I wrote an article talking about how to save boat loads of money by purchasing the car of your dreams but only after it is two to three years old. This week I want to talk about how leasing a car really works and some tips to save you more money on that next car purchase or lease.

What is a lease? A lease is an agreement you enter into to rent your car for a predetermined length of time (usually 24 to 36 months) for a predetermined monthly payment, and for a set number of miles. These payments are always less than the payment would be if you purchased the same car on the same day. The lower payment means that the car looks more affordable on the surface but inside of that lease agreement are all kinds of terms that can cost you far more than just the lease payments.

To begin with, why is the payment less expensive with a lease than with a loan for the same car? When you lease you are only paying for the estimated depreciation during the length of that lease rather than the entire loan balance you would pay back during that same time frame. As an example, you borrow $25,000 and sign a 36-month loan agreement at 5% giving you a payment of $749.00 which is a very hefty car payment by today’s standards and for many people that payment is not an option based on their income and budget. However, if you could swing that payment for those 36 months you now have a free and clear car with a lot of life left in it and if you were smart and disciplined you would continue to make that big payment but now into a tax-free account. (More on this in next week’s part 3)

In contrast, when you sign a lease on that same car for 36 months your payment might only be $300.00 for a 36-month lease which is much easier on your pocketbook. However, after the 36-month lease, you still have a balance to pay off if you want to own the car. This balance is called the residual value and must be paid off either by cash or with a new loan. Most people will not have the cash to pay off the car and so if they decide to own the car they now take on another loan for several more years to actually get the car paid off. Most people do neither of the above but turn the car in and get the next newest model and take another lease payment and so on and so on until they are old and gray.