Consider This . . . Automobile Lease

By Jimmy R. Hammond, CPA

According to the latest automotive industry statistics, the American public will have purchased in excess of 17 million new automobiles and light trucks when the final tally is made for 2003.

As you might expect, the average vehicle price has risen constantly to record levels. According to a recent press release from Nissan, however, their 1.4 million sales units averaged only $20,500 per vehicle. You don't have to be very observant to notice that many of the higher- end imports and SUV offerings from Mercedes Benz, Cadillac, Hummer and Lincoln can easily reach or exceed $50,000, or more than twice the average new vehicle price.

There are many incentives, like deferred payment plans similar to the one offered to LeBron James' mother when she bought her phenomenal basketball-player son a new Hummer for high school graduation, even though the balance was due after he was drafted into the NBA. Most of us, however, look to general rebates and special financing rates or a few special programs like those geared to the military, new college graduates or first-time buyers. Unless you are one of the few who shows up with cash or check for the new wheels, you'll end up in the finance manager's office looking at every scenario that can lower that final monthly obligation, whether it is a lease or purchase contract.

It is worth noting that, for the first time in more than a decade, the number of vehicle leases dropped by almost 40 percent, or approximately 6.5 million leases in 2001. That trend continued into 2002 and 2003 with declines in the 7 percent range, or an additional decline of 2 million contracts, according to the Association of Consumer Vehicle Lessors at www.acvl.com.

Leases now make up less than 30 percent of the annual automobile financing contracts. Many analysts indicate that aggressive sales promotions, declining residual lease values, home equity loans and customer credit worthiness have caused this financial product growth to ebb. Regardless, automobile leases remain significant and still represent a viable financing alternative for many consumers. What is a lease and exactly how does it work? First you have to understand that an automobile lease is nothing more than a long- term rental agreement that requires you to pay for the used portion of the vehicle value, plus interest and sales taxes. Unlike Hertz or Avis that quote daily and weekly deals, this contract is quoted as a monthly rate for an extended period after several factors are considered and calculations made. The first and most significant calculation is to determine what the value of the vehicle will be when you return it to the dealer at the end of the contract. Mercedes Benz, BMW, Porsche and Lexus have set the standard for residual values after 48 and 60 months at 40 to 50 percent. American cars have greatly improved residual values, but 20 to 30 percent is still common. Remember that a 10 to 30 percent lower residual value means that on a $50,000 leased vehicle you would be expected to pay $5,000 to $15,000 more to the lessor over the term of the contract. This calculation is made by the dealer but can be made online at most automaker sites or at sites like www.federalreserve.gov/pubs/leasing or www.autosite.com/new/loanlse/calc.asp or www.leaseguide.com/lease03.htm. It should be very evident why the lease payments often are less than a regular purchase payment since you are only paying for, not buying, just a fraction of the vehicle's value plus other costs.

Taxes and interest rates can be the same as they might be in a purchase contract, although you may pay more interest as the outstanding principal remains higher throughout the term of the lease.

The lease has another factor that can change the lease cost considerably over time. Leases are structured based on your estimate of miles driven per year, such as 10K, 12K or 15K. Mileage in excess of the contract rate will cause you to pay a special assessment from 10 to 25 cents per mile when the car is returned at the end of the lease---2,000 extra miles a year for 4 or 5 years can result in an assessment of $2,500 at the end of the contract, which can be a nasty surprise. Stay within your mileage limits, unless you intend to exercise your option to buy the vehicle at the stated residual price.

Another problem with a lease and, to some degree, with a purchase occurs when the vehicle is destroyed by accident and the depreciated value of the car is worth less than the outstanding debt or, conversely, the amount that the insurance company is obligated to pay you. This potential insurance dilemma can be cured with gap insurance, often available through the dealer or your bank.

Regardless, the sum of these lease parts will no doubt still result in a payment that could be one-third to one-half the purchase payment for the same vehicle. Many leases require less up-front money, or capitalization as it is known in the lease contract. At the web sites referenced above, there are extensive Q & A sections that will supplement this leasing primer and help you figure out if you are a proper candidate for a lease. Your tax advisor is another resource who can help with this decision.

For many, the new 72-month financing terms, with rates at this writing as low as 5.9 percent and with low down payments, may give you an amount that is closer to a lease payment than a conventional payment calculated for 36 months with 20 percent down payment. Unfortunately, if you choose to sell or trade the vehicle at any time during this extended-purchase period or during the lease contract, the vehicle value may be worth less than the outstanding debt. This can be a problem since most Americans have become quite accustomed to buying a new car every 3 to 4 years.

As you can see, there are a few more questions to be answered when leasing, but the most significant questions relate to you and what you intend to do with the vehicle in the long term. Rest assured that there are no secrets and no wrong choices, just different ones. Happy shopping!

If you have comments or suggestions or have an idea for a future computer or business topic, e-mail me at Jimmy@InsideAnnapolis.com.