Automotive leasing has been an alternative to purchasing since the early 1950s, but if we can judge from the calls we get regularly on WBZ-AM1030’s Jay Talking program, 70 years later, we still don’t have a handle on how leasing works. Callers have a lot of questions about the process, especially what happens when the lease ends.
What is Leasing?
Leasing is simply paying for the use of a vehicle for the term of the lease, rather than buying the vehicle outright. You’re paying for the depreciation of the vehicle from the time it was brand new until the time you turn it in.
When you lease a vehicle, the payment is based on four main factors (not including tax, fees and licensing):
Capitalized Cost – The negotiated price of the vehicle you’re leasing. It’s the same price you’d negotiate if you were deciding to purchase the car rather than leasing it.
Money Factor – Your interest rate. It’s the Annual Percentage Rate divided by 2,400. If you’re presented with the Money Factor, you can figure out the APR by multiplying the Money Factor by 2,400.
Residual Value – Residual value is the predicted value of the vehicle at the end of the term of the lease.
Term – The number of months you’ll be leasing. Leases are typically 36 months, but can be more or less.
Residual Value: The Most Important Thing To Know at Lease End
As you arrive at the final months of your lease, the most important think to keep in mind is the Residual Value that was presented to you at the beginning of the lease. It’s going to help you make a lot of decisions about what to do next.
Residual values are typically set by the lender, and a lot of its information comes from ALG (Auto Lease Guide). The lease value is a predicted value of what the car is going to be worth at the end of the lease, and ALG and the banks are usually pretty good at figuring it out, but there have been times when they were completely wrong.
Take the Financial Crisis of 2007 and 2008 for example: If you had leased a giant luxury SUV in 2005 and were about to turn it in in 2008, the residual value was probably a lot higher than the actual value of that vehicle on the street in 2008.
Conversely, if you’d leased a Prius in 2005 and the lease term ended in 2008, you may have been sitting on a vehicle that had equity, opening your options considerably as the lease came to a close.
You’ve got three options when the lease comes to an end, and there are good reasons to either take or rule out all of them:
Rolling Into A New Lease – When you lease another vehicle, you show up at the dealer, turn the lease in and drive away in another car, with another monthly payment.
Buy the Vehicle You’d Been Leasing – If you liked the vehicle, or there was a good financial reason to purchase it, you can buy it from the LEASING COMPANY which is an important consideration we’ll get into in a moment.
Walk Away – In this scenario, you drop the vehicle at a dealership (which one, we’ll help you determine in a minute), hand them the keys and take a bus home.
Sell It To a Third Party – This isn’t an official means of disposing of a car, but the question comes up a lot: What happens if someone you know wants to buy the vehicle? There are unofficial ways to do it that are advantageous to both you and the potential buyer.
Let’s take a look at all three scenarios and what your considerations should be:
Scenario A: Rolling Into a New Lease
This is really the only scenario that can happen at any time during the lease term. Say you’re 24 months into a 36 month lease and you swing by the service department at your retailer to have your oil changed, tires rotated and a few other service options. At that point, a sales representative may visit you in the waiting room and present you with an offer to flip into a brand new car for the same (or less) monthly payment. They simply swap the plates, have you sign a few papers and you’re back from lunch with a brand new car.
It’s not quite as easy as that, and you really need to understand the numbers if this happens. Right now, in March of 2019, the predictions for new car sales numbers are not great. Simultaneously, used car sales are picking up, although that’s only true for certain models and vehicle types. There’s a huge glut of sedans on the used market as that vehicle style has waned in popularity.
What this has to do with that offer you were presented in the waiting room is this: Dealers are hot to move new cars, and if you’re already driving a popular model — say a well-equipped Honda CR-V with well under the 12,000 mile per year cap, that has a clean CarFax report — the dealer probably has a list of potential customers that would love to get their hands on it.
Before you sign away another three years for a lease on a new vehicle, it’s important to know what your current leased vehicle is worth. A quick phone call to the finance company that leased it (Say, Honda Financial Services) will tell you exactly what your lease buyout is at that time. Running the car through the used car department for an appraisal will also tell you what the used car manager will give you for it in trade. If it’s worth more than the lease buyout, it may be worth your while to shop it around to a handful of dealers before making your decision.
If you’ve gone all the way to the end of the lease, the same caveats apply. Know what the residual value is, and shop the vehicle around to two or three other dealers to find out what it’s actually worth. If it’s worth a lot less than the residual, flipping it into a new lease is kind of a no-brainer. If it’s worth significantly more, you may be able to make some money from the used car department, or even more if you decide to sell it yourself.
Scenario B: Buy the Car You’ve Been Leasing
You may love the car you’re leasing and want to hold onto it after the term of the lease is over, but take sentiment out of the equation for a moment. If you’ve leased a car that’s worth less than the lease buyout, there’s not a lot of financial sense in buying it, when you could simply lease another one for the same, if not less in a monthly payment.
Look at this scenario, though: Say you had leased a 2016 Jeep Wrangler Unlimited Rubicon and the term was coming to a close. You’ve never been off-road with it, you’ve kept it in impeccable condition and you’re under the mileage cap. A vehicle like that is like having money in a savings account. Even a lower trim like the Sport typically has a residual value of 74 percent of MSRP. A high trim Rubicon with all the options can be even higher.
That might not seem like a great buy at the end of a lease, but amazingly, it’s a better deal than you’d ever find on the used market.
Buying it offers a singular opportunity, too: It’s the only time that you’ll ever conduct a transaction directly with the manufacturer, without a dealer involved. You can log into the leasing company’s website and find out exactly what the buyout number is. With no negotiation, you simply send a check and a few days later, you receive a package from the leasing company with all the paperwork you’ll need to register the vehicle in your name, rather than the leasing company’s.
Scenario C: Walk Away
This scenario is just as the label describes it: You toss your keys on the counter, sign a receipt and walk away from the car.
Any of these scenarios require an inspection by the dealership for abnormal wear and damage, but absent of any issues, you’re done with the transaction, with one additional note: Most leases have a built-in incentive to lease another car called a Lease Disposition fee. The dealer doesn’t charge it, the leasing company does, so it’s not negotiable. It’s generally in the $350-$400 range — enough to be an annoyance, but not enough to force you into another lease.
Scenario D: Sell it To A Third Party
A lot of folks think that having a buyer lined up for their lease is a good way to accomplish this. You see this all the time in Craigslist ads like “Take over payments,” etc. It doesn’t work that way. The only person — besides yourself — who can buy a vehicle this way is an immediate family member. A third party cannot buy the vehicle from the leasing company. If you want to sell it to a third party, you have to buy it yourself, register it in your name, get a title and then transfer it to the new owner. It’s a pain in the neck, and depending on what state you live in, you could be on the hook for a lot of money in sales tax.
The less painful way to do it is to talk to your dealer. We just went through this process with AutoFair Volkswagen in Merrimack, NH. The used car department was happy to facilitate the process. We had a potential buyer, and we all knew what the lease buyout number was. The used car manager offered two options: He could run it through the inspection process to be Certified, which offered the advantage of a 24-month, 24,000 mile bumper to bumper warranty, or uncertified came with a 12-month, 12,000 mile powertrain only warranty.
It added about $3,000 on top of the lease buyout, but the value of the Certified Pre-Owned warranty was at least $1,500. Buying it from me directly offered zero warranty. Adding in the cost of sales tax and all the other registration fees came pretty close to $1,500, with no warranty protection.
All of this assumes that you’ve got a vehicle in pretty decent condition, that hasn’t gone over the mileage cap.
Condition is a major stumbling block. Manufacturers like Volkswagen offer a handy guide to things that they consider normal wear and others for which you’ll be charged. Curb rashed wheels, broken windshields and scratches will all add up to penalties.
A lot of body shops and detailers run “Lease Return Specials” that clean up a lot of these issues, plus make the car as spotless as possible when it’s time to turn it in. For the $150 they typically cost, they’re a good investment.
Mileage is going to be the area where a lot of lessees end up on the wrong side of the lease. Those caps are hard and fixed, and if you’re over the mileage, it’s going to cost you.
A note on collisions: If your vehicle has been in an accident and you’ve claimed it on your insurance, your car likely has a dirty CarFax report. It doesn’t matter if it was a minor fender-bender or a collision where the airbags deployed, that CarFax is going to mean that your car is essentially worthless to a franchised auto dealer for anything else than wholesale auction fodder. Check the used car inventory at your favorite franchised dealer and the vast majority of cars in it have a clean CarFax report.
That doesn’t mean you can’t turn the car in, or that you’ll pay any penalty if the car has been repaired properly. But it does mean that you have a lot less negotiating power.