Leasing Benefits

Most consumers understand the buying process. Leasing, however, can be a bit murkier. Before we talk about the benefits of leasing, let's review how it works.

Michael Kranitz, creator of LeaseWizard.com software and author of "Look Before You Lease: Secrets to Smart Vehicle Leasing," explains that lessees are paying for two things in any lease deal: the car's depreciation and the cost of money. Depreciation is merely the difference between the car's capitalized cost and its residual value. The capitalized cost is made up of the negotiated purchase price and whatever other taxes and fees you elect to fold into the lease, while the residual value is the vehicle's predicted wholesale value at the end of the lease term. Residuals are a key determinant of your monthly payment. Higher residuals mean lower payments, but they also mean the car will be more expensive if you elect to buy it at the end of the lease.

In buying, the "cost of money" is known as "interest," which isn't applicable in leasing because no money is borrowed. Instead, consumers pay a money factor — consider it a rental charge that allows lessors to make a profit.

Those are the basics. Now, what are the benefits?

Leasing Benefit No. 1: Driving a New Car

Leasing allows consumers to always have a new or late-model car in the driveway. This has some obvious benefits, including the ability to keep up with the industry's hottest vehicles and trends. This may not be the most prudent reason to buy a car, but leasing is often a lifestyle choice rather than a financial one.

These same drivers benefit from having the latest safety technology, such as side curtain-type airbags or an electronic stability system. Plus, newer cars have the latest creature comforts such as an OnStar communication system, advanced stereo equipment or DVD entertainment systems. Technology advances faster than a typical loan term.

Another benefit of driving a late-model car is fewer repair bills. If you're leasing to avoid future haggling with your mechanic, make sure the lease term is shorter than or equal to the car's bumper-to-bumper warranty.

Leasing Benefit No. 2: Cash Flow

Leases are attractive to many car buyers because they can get more car for a lower monthly payment. How's that possible? Lessees only pay for the depreciation on the car, not the entire vehicle. In effect, they're renting the car for the length of the lease.

Leasing also reduces your initial cash outlay. Kranitz believes this allows for a more intelligent use of cash rather than putting it toward the questionable investment of car ownership. "A car is a depreciating asset," he says. "Why do I want to own it?" To illustrate his point, Kranitz suggested a scenario in which a real estate agent pitched a house that would be worth half its sale price in five years. "You'd laugh," he says.

There are other financial advantages in leasing. If you use your car for your job, leasing payments can be written off as a business expense on your tax returns. Additionally, lease obligations don't show up as debt on a credit report, which may be important to companies that buy multiple cars for business use.

Leasing Benefit No. 3: Subvented Lease Deals

More automakers are starting to offer incentives on leasing rather than big cash-back offers to those who buy. Such leasing incentives are called lease subvention.

"The cycle of leasing is really driven by two things: manufacturer advertising and subvention [subsidies]," says Randall McCathren, managing director of the Association of Consumer Vehicle Lessors.

Manufacturers subsidize, or "subvent," leases to find customers who will buy slow-selling models. Today, about 50 percent of leases are subvented, compared with 28 percent in 2004, according to Art Spinella of CNW Marketing Research.

For automakers, 2008 has turned into a hard year as sales of large SUVs and pickup trucks plummet, pushing down the residuals or expected value of these assets that automakers rely on to decide leasing terms. Tarry Shebesta, president of Automobile Consumer Services, believes these factors will most likely reduce subvention in the near future, until automakers can sort out where the market is going. "Subvention was crazy in the earlier 2000s," says Shebesta, and "subvention will be pulled back [to become] more inline with market values."

As automakers shut down or retool SUV and pickup factories to build cars people demand, subvention will slowly decrease as well. Automakers offer subvention deals because they're in the business of putting cars on the street. "They're just trying to get you into the car," Kranitz says. "They get hit at the end when the lease comes due." That philosophy of "move units now, pay later" is directly to the consumer's benefit.

Leasing Benefit No. 4: Avoiding Negative Equity

Even with today's incentives, many buyers are signing up for car loans of six and seven years. At that rate, the car will depreciate much faster than equity builds. In the industry, these purchasers are known as being "upside down."

This fact is borne out by data from the Power Information Network, an affiliate of J.D. Power and Associates. The percentage of cars traded in with outstanding loan debt has decreased from 38 percent in 2004 to 28.7 percent in 2008, according to PIN. But average loan terms jumped from 62 to 64 months during that time. These buyers transferred an average of $3,986 of debt from their old car to their new car's loan in 2008.

"The negative-equity person also [has] a higher interest rate, a longer loan, higher monthly payments and a lower down payment," says Tom Libby, director of industry analysis for PIN.