Car Dealer Terminology Explained—Part 2:Leasing a New Vehicle
Car leasing does not work the same way as car buying. Prior to leasing a new vehicle, it is important for consumers to understand how leasing is different, as well as to understand the unique terminology associated with vehicle leases. This article explains common leasing terminology to help consumers educate themselves about the leasing process and the concepts associated with it. The words and phrases are listed below, in alphabetical order.
Sometimes called an initiation fee, an acquisition fee is what a person leasing a vehicle pays at the beginning of the lease for the privilege of leasing a vehicle. Nearly all leases contain either an acquisition fee or a termination fee, which is paid at the end of the lease. People leasing a vehicle should expect to pay one of these fees, but not both. Be sure your lease contract stipulates which fee is required, and the amount of the fee.
When leasing a vehicle, the capitalized cost is the negotiated selling price of the vehicle, upon which the lease payments are based. When leasing a model that is in high demand and low supply, the capitalized cost may be the Manufacturer's Suggested Retail Price (MSRP) or higher. Leases for other models should have a capitalized cost that is near dealer invoice price.
Keep in mind that many advertised lease deals are subsidized leases, meaning that the auto manufacturer determines, in advance, the financial variables used to calculate the lease payment and takes on a certain degree of risk in order to create an attractive or class-competitive payment. Generally, consumers cannot negotiate the capitalized cost of a subsidized lease.
Capitalized Cost Reduction
When leasing a vehicle, the capitalized cost reduction--a fancy term for down payment--equates to the amount of any money you put down to lower the overall cost of the lease. Often, subsidized leases require a capitalized cost reduction to help eliminate some of the financial risk taken on by the auto manufacturer in order to create an appealing and competitive lease payment.
Depreciation refers to the amount of value a new vehicle loses, both the moment it is driven off the dealership lot and becomes a used car, and over time as the vehicle ages and accumulates miles. This term is most often used when discussing a lease, rather than a loan, as it has a much greater financial impact on the monthly payment on a lease deal.
Sold as an extra-cost item, an extended warranty provides protection against vehicle defects after the original factory warranty expires. When leasing a car, an extended warranty is usually unnecessary because most leases are written to fall within the time and mileage limits of the standard warranty. Generally, experts agree that consumers should not lease a car for longer than the time and mileage limits of the original factory warranty.
An abbreviation for "finance and insurance," F&I refers to the car dealership department that finalizes the details of the consumer's lease contract while the new vehicle is prepared for delivery to the consumer. When leasing a new vehicle, the F&I department may offer to sell the consumer additional products and services, including service contracts, gap insurance, anti-theft protection, and more.
Gap insurance protects a consumer who leases a vehicle against the difference between the value of the vehicle and the total cost of the vehicle's residual value plus any remaining lease payments due as a part of the lease contract. Because the leased vehicle depreciates, especially during its first years in service, the amount of money a car insurance company is willing to pay in the event the leased vehicle is stolen or damaged beyond repair is sometimes less than the total obligation held by the consumer who leased the vehicle. Without gap insurance, the consumer may owe hundreds or thousands of dollars in addition to whatever settlement amount he or she receives from a car insurance company.
The amount of interest paid with each lease payment is called a money factor, or a lease rate. To convert the money factor to the equivalent of a conventional loan interest rate expressed as a percentage, multiply the money factor by 24. For example, a money factor of .0028 converts to the equivalent of a 6.7% APR interest rate on a conventional car loan.
Residual value, also called depreciation, is a leasing term that describes the predicted amount of money that a vehicle will be worth at the end of a lease. Residual values are often expressed as percentages of original vehicle value. For example, a car with a $25,000 MSRP and a 45% residual value after 4 years is predicted to be worth $11,250 after 4 years of ownership.
A service contract is an agreement to pay up front for discounted service at the dealership that provided the lease for your vehicle. Service contracts work well for people who plan to have a dealer service the vehicle and who don't require flexibility with regard to service provider choice. Before buying a service contract, make sure the brand of vehicle selected does not offer free scheduled maintenance for a limited time.
Spiffs are temporary incentives paid to car dealers and car salespeople to help lease more new vehicles. The more new vehicles leased within a certain period of time, the more extra money the dealership or salespeople can make. For individual deals, however, the amount of the spiff is generally not large enough to make a significant difference in terms of the monthly lease payment, even if the dealer or salesperson wants to pass part or all of the spiff to the consumer in order to bring the deal to a close.
A subsidized lease is one for which the financial variables used to determine the monthly payment are set in advance by the auto manufacturer. Typically, subsidized leases are designed to provide an appealing monthly payment that is competitive within the vehicle class and often require that the car company take on a certain degree of risk associated with the financial variables used to generate the payment. Sometimes the car dealer can adjust the financial variables to make the lease more appealing to a consumer, but any modifications typically result in minor changes to the terms and payment.
A leasing term that is sometimes called a disposition fee, a termination fee is what a person leasing a vehicle pays at the end of the lease for the privilege of leasing a vehicle. Nearly all leases contain either a termination fee or an acquisition fee, which is paid at the beginning of the lease. People leasing a vehicle should expect to pay one of these fees, but not both. Be sure your lease contract stipulates which fee is required, and the amount of the fee.
Consumers who want to trade their old vehicle in when leasing a new vehicle should be prepared to accept trade-in value for the old vehicle, rather than retail or private party value. This is the amount of money a car dealer is willing to pay for the consumer's old vehicle and is typically lower than what the consumer could get for the vehicle by selling it himself or herself to a private party.
The reasons that trade-in value is lower than other used car valuations is because the car dealer assumes all risk associated with the old vehicle by accepting it in trade. If the dealer can sell the old vehicle, the dealer must pay to have the car inspected, reconditioned, and detailed prior to sale. If the dealer chooses not to sell the old vehicle, it must be transported to auction and sold for what is likely to be a low amount.
If a consumer wants to trade in an older vehicle to lease a new vehicle, and the consumer owes more for the older vehicle than it is worth as a trade-in, the consumer is "upside down" on the trade-in. This is not a deal-breaker for the car dealer. However, consumers who are upside down on their trade-in need to understand that the difference between the value of the older vehicle and the amount owed on the older vehicle will be rolled into the lease payment on the new vehicle, resulting in a higher payment--perhaps by a significant amount.
Wear and Tear Charges
When a consumer leases a new vehicle, the consumer does not own the vehicle (the financial institution or leasing company holds the title). Rather, the consumer is borrowing, or renting, the vehicle over time. At the end of the lease, the vehicle must be returned to the financial institution that provided the lease.
If a returned lease vehicle has been driven more miles than were agreed upon at the start of the lease, shows an unusual amount of wear on the inside or the outside due to indifferent care and maintenance, or exhibits unrepaired damage, the financial institution that provided the lease will charge the consumer for excessive wear and tear, an amount that could total hundreds or even thousands of dollars.
Consumers who lease a vehicle must take very good care of the leased vehicle. In the event the vehicle is driven too many miles or has not been properly cared for, the consumer might want to consider buying the vehicle at the end of the lease to avoid excessive wear and tear charges.