Drive a brand new car every three years, stay under warranty forever, and pay a lower monthly payment than buying. It sounds like the perfect financial hack, which is exactly why over 25% of new cars on the road today are leased.
But dealerships love leasing for a different reason: the financial jargon is so complex that it is incredibly easy to hide massive profit margins right in plain sight.
You Are Financing the Depreciation
When you lease a car, you aren't paying for the car itself. You are paying for the exact amount of value the car loses while you drive it. If a $40,000 car will be worth $25,000 after 3 years, you are paying the $15,000 difference (plus taxes and fees).
This remaining $25,000 is called the Residual Value. A high residual value is great for leasing, because it means the car doesn't depreciate much, so you pay for a smaller chunk of the car.
The Money Factor Trick
If you ask a dealer, "What is the interest rate on this lease?", they will often dodge the question or tell you that leases don't have interest rates. Instead, they use a term called the Money Factor.
"The Money Factor is just an interest rate in disguise. To translate it into an APR that you can actually understand, multiply it by 2,400."
If the dealer says your money factor is 0.00375, that sounds like a tiny number. But multiply 0.00375 by 2,400, and you get 9% APR. Suddenly, that lease doesn't look like such a great deal.
The Down Payment Trap
Never put money down on a lease. This is known as a Capitalized Cost Reduction. If you put $3,000 down on a 36-month lease and total the car on the drive home, your insurance will pay off the leasing company, but your $3,000 is gone forever. It vanishes into thin air.
Instead, roll all fees into the monthly payment, or keep that $3,000 in a savings account and use it to supplement your higher monthly bill. If you want to see exactly how these numbers break down, head over to our Lease vs. Buy Simulator to expose the dealership's math.