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Common Lease Questions and Terminology

Common Lease Questions and Terminology

By Jeff Youngs, February 24, 2012
Vehicle leasing is a contract to acquire the use of the vehicle for only a specific period. Most often it is for a two- or three-year period of time. In most cases, the lease payment will be lower than the purchase payment, making leasing increasingly popular as the price of new vehicles continues to rise.

Why are lease payments often less than finance payments?
A finance purchase requires payment for the full negotiated value of the vehicle during the term of the loan (the full cost of the vehicle can be determined by adding the down payment, monthly payments, interest, taxes, and any other associated fees). Since you will own and take title to the vehicle at the end of the term, the bank has little interest in the vehicle itself-other than its collateral value during the loan. A lease only requires you to pay for the depreciation of the vehicle during the contracted term in which you wish to operate it. In effect, you are only paying for the portion of the vehicle you use.

Additionally, with a lease, the leasing company owns the vehicle. This relationship means the lessee has a responsibility to maintain the vehicle according to strict standards defined in the lease contract. Specific terms set limits as to the amount of damage ("wear and tear") or mileage ("mileage allowance") allowed on the vehicle during the lease period. Leasing companies also require their vehicles to be properly insured and maintained during the lease.

Are leases complicated?
The most complicated part of a lease is the terminology. Once you understand common lease phrases and how the process works (see Leasing: Is It Right for You?), you may that find leasing makes sense for your next vehicle.

Common lease terminology:
  • Acquisition fee-A fee designed to cover many different types of miscellaneous administrative costs in the lease. It is also commonly called a "bank fee."
  • Cap-reduction payment-A cash payment-paid at the beginning of the lease-that is used to reduce the monthly payments. It becomes part of the drive-off fees and is not refunded at the end of the lease.
  • Capitalized cost-The negotiated cost of the vehicle with all options. Negotiating down the capitalized cost will lower the monthly payments of the lease.
  • Destination charge-The cost of transporting the vehicle from the final assembly point or port of entry to the dealership. It is not negotiable.
  • Drive-off-The total amount of money due when the lease agreement is signed. The drive-off often includes Department of Motor Vehicles (or similar state agency), fees taxes, and deposits.
  • Gap insurance-New vehicles depreciate rapidly during the first few months of the lease. If the vehicle is crashed or destroyed, gap insurance can help pay the difference, or gap, between the amount the insurance company will reimburse and the amount due to the leasing company. Many leases include gap insurance.
  • Mileage allowance-The maximum amount of miles the vehicle is allowed to be driven during the term of the lease. Excess mileage is charged at a predetermined rate, typically 12 to 15 cents per mile (but can be as much as 20 cents per mile). The mileage allowance can be negotiated at the start of the lease.
  • Money factor-The finance charge, often called the money factor in a lease, which is just another term for interest rate. To determine the equivalent interest rate of your money factor, multiply the number by 2,400. For example, a money factor of .002 is equivalent to an interest rate of 4.8 percent.
  • Purchase option-Many leases offer the buyer an option to purchase the leased vehicle, either in the middle or at the end of the lease period, for a pre-determined price.
  • Residual value-This is the predicted value of the vehicle at the end of the lease. Models with high residual, or resale, value will be less expensive to lease. Since residual values vary by manufacturer and financing bank, the most accurate residual information is supplied by the dealer at the time of sale.
  • Security deposit-An amount held in deposit in the event obligations are not met during the lease. In some states, dealerships collect the last payment in lieu of a security deposit.
  • Wear and tear-The term for normal and natural wear and usage of interior, mechanical, and exterior parts of the vehicle. The lease contract will define whether small scuffs in the leather, tire wear, chips on the paint, or any other specific items are considered normal wear and tear. Excess wear and tear will be charged at the end of the lease.
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