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Should You Ever Lease a Used Car?

Notwithstanding the name of this article, a used car with reasonable lease terms can be a good deal. We don't want to scare you away from considering a lease on a used car. We do want you to know what's important in order to make an informed decision as to whether a used car lease is right for you and if so, that you know how to make the lease a successful one.

Used: No Stigma Here

In the not-too-distant past, buying a used vehicle carried some sort of social stigma. If you couldn't afford a new car, then obviously you weren't doing too well financially. A new car carried with it some sort of perceived status.

While still true to some extent, a new car clearly does not carry the social significance it once did. New cars and trucks look and perform well for many years. Thirty years ago the 100,000 mile mark was considered a full lifetime for most vehicles. Today, we expect that same 100,000 miles to be largely trouble free. Now, 150,000 miles-plus is generally considered to be the useful life of a well maintained vehicle.

In today's market, a vehicle with 50,000 miles is not a high maintenance hunk of iron with half its life gone. It's now viewed as a low mileage vehicle just getting warmed up. More and more people of all income levels are choosing used vehicles for their transportation needs. Especially when manufacturer's "Certified" programs are factored in, they have come to the conclusion that used is the smart buy -- or lease. The non-traditional used car buyer is driving the used market.

Given this growing interest, manufacturers and finance companies are tripping all over themselves trying to tap into this market by offering leases on used vehicles. Of course, the marketing folks at these companies have thrown their two cents in, so now you'll be comforted to know that you are buying a pre-owned vehicle, not a dirty old used one.

Currently, less that 5% of used vehicle retail transactions are handled through leases, far below the rate for new vehicles.

The Concept of Leasing

Although this is not intended to be an exhaustive study of leasing, Used Cars felt it was important to cover the basic concepts. Many consumers are woefully uneducated about what a lease is, not a good thing when entering into a lease!

Most of the leasing concepts, benefits, and pitfalls are the same for used cars as they are for new cars. All the same terms apply, and the principles used to negotiate a good lease deal on a new car also apply to used vehicles. You need to understand three basic concepts behind a lease:

You are renting the vehicle. You do not own it.

You are paying for the depreciation of the vehicle during the time you have it.

You are also paying interest (often called a money factor) on the full value of the vehicle as determined in the lease.

The downside remains the same: perpetual payments and higher overall transportation costs over the long run. However like a new car lease, leasing a used car can put you into more car for the same monthly payment and to some people that's worth the price of admission. And when you opt for no capitalized cost reduction (something we highly recommend) you get the benefit of freeing up cash for other purchases. Or if you're really disciplined, you can invest it and hopefully help offset the finance charges you are incurring on the lease.

For an excellent source of leasing information, visit the Federal Reserve's unbiased information at http://www.federalreserve.gov/pubs/leasing.

Who Really Benefits?

With the popularity of new car leasing soaring, leasing companies and manufacturers are facing an ever-increasing glut of clean, late-model off-lease vehicles. The traditional way of disposing these vehicles, dumping them at auction, depresses their wholesale and retail values. This is not an ideal situation for these finance sources, as their objective is to recoup as much of the original value of the vehicle as possible.

You can rest assured that two of the primary objectives of the various used car leasing programs available, including the many "certified" programs, have nothing to do with your benefit. They are to extend the profit cycle of the vehicle for the leasing company, the manufacturer, and the dealer, and to maintain the residual values on new cars and trucks.

What does a residual value on a new car have to do with a used car lease? High residual values on new models benefits finance companies, manufacturers, and dealers in two ways. First, all other factors being the same, it will help them lease more new vehicles because they are able to offer a lower lease rate for a given capitalized cost (what the vehicle costs you). Remember, depreciation is the biggest component of what you are really paying for in any lease. The less depreciation, the less your monthly payment needs to be to cover it. Alternatively, a higher residual lets dealers sell or lease that model closer to the manufacturers suggested retail price (MSRP) -- or even above -- while still maintaining a competitive monthly payment.

To simplify the picture, high residuals give the dealer more room to play with the price -- and thus profit -- when negotiating with an uneducated consumer. And the lower the lease rate the finance companies can offer (while maintaining profitability), the more vehicles they can lease.

Still, all of this doesn't mean that you can't negotiate a reasonable deal. You just have to know what to look for.

Warranty Issues

There are many claims with regards to warranty coverage on leased vehicles, particularly if the vehicle has been "certified". Look closely. Some of these vehicles do come with rather extensive extended coverage that does indeed offer value-added to the vehicle. However, others do not. Often the "extended" coverage is nothing more that the remainder of the original factory warranty.

VMR recommends that you get a list of what is covered -- and what isn't -- in writing. You should also get in writing what the term of coverage is on the specific vehicle you are considering. Don't settle for the generic marketing brochure that talks in general and sometimes vague terms. You need to see specifics about the vehicle you are looking at.

If you determine that the scope and quality of the coverage is acceptable, the next issue you need to address is the lease term. NEVER LEASE A USED VEHICLE BEYOND THE WARRANTY PERIOD. We cannot emphasize this enough.

As an example, say you have your eye on a two year old car that offers lease terms within your budget. The term of the lease is for three years, but the warranty coverage is only good for two more years. This leaves you exposed for a full year to any kind a mechanical breakdown, and that is a significant difference from most new car leases, which are fully covered during the length of the lease. Transmission goes? That'll be $3000 please. Waterpump? $300. ABS sensor shot? $750, thank you very much. You get the idea.

Yes, you'd still have to shell out the money if you had purchased the car. The difference is that you're shelling out the money for somebody else's car. Having done that, you may feel compelled to purchase the car at lease end. The problem with that is that you'll end up paying far more for the car than if you had simply purchased it to begin with. Not a pretty picture, is it? Used Cars does not feel that exposing yourself to potential mechanical repairs is worth the risk of leasing a used car that does not cover full warranty coverage through the full lease term.

Service Issues

Ok, let's assume that you've got the warranty issue covered. Good coverage will be in force the entire life of the lease. You still need to take into consideration service costs, which are not insignificant with today's sophisticated and complicated vehicles. Timing chains, tires, batteries, brakes, etc. will in all likelihood need to be renewed during a two-or three-year lease on a two- or three-year-old vehicle. Although not to the degree of the warranty scenario, again you have to ask yourself if you want to be putting money into someone else's vehicle.

I'm In! What do I Need to Know?
No doubt about it, late-model used vehicles can offer tremendous value. Taken from a purely logical position, however, a used car lease is not the best way to take advantage of current market conditions. Interest rates are low, and down payment requirements are very liberal on late-model used vehicles. Buying it and keeping it will save you thousands of dollars in the long run.

But you've considered the above and have decided to lease a used vehicle (I need that Lexus!). You've got the warranty issue covered, and the service issues don't bother you. What do you need to know?

First of all, you still need to negotiate the price of the vehicle. Used Cars lists market values for almost all domestic and import vehicles sold in the US, so use this magazine as a guide. Do not let the dealer sell you on low monthly payments and that the value doesn't matter in a lease.

You should always know the following: term, price, interest rate (also known as the money factor), residual value, up-front fees, taxes, lease-end fees such as excess mileage (if any), and the annual mileage allowance. Also check to see if there is a mileage credit for unused miles. Do not sign anything unless these are all clear to you. Since 1998, dealers are required by law (Regulation M) to clearly disclose the variables that affect the cost of a lease.

The theory behind a lease is that you only pay for what you use. A lease will amortize only the difference between the capitalized cost and the residual value. You will pay interest charges, however, on the full capitalized cost. Below is a simple rate calculation to help illustrate what you'll be seeing.

Capitlized Cost--$20,000
less down payment--$0
Total Cap Cost--$20,000
Residual Value--$14,000
Term (months)--24
Interest Rate--7.75%
Money Factor (interest rate/24)--.0032
Amount Financed--$20,000
Amount Amortized (Cap. cost - RV)--$6,000
Monthly Charges
Interest on residual--$90.42
Sales Tax* (5% of monthly pmt)/month--$18.05
Monthly Payment--$379.15
*Sales tax rate and terms vary by state