Leasing is Not Renting
Car leasing is often confused with renting. The two are very different.
Much of the confusion comes from the fact that many people are more familiar with apartment renting and leasing, which are essentially the same thing.
Car leasing is not like apartment leasing. Car leasing is a financing method that is based on paying for the depreciation in value of a car that occurs as it ages and is driven. All cars depreciate in value from the moment they're driven off the dealer's lot.
Lease companies estimate the future resale value of car, called "residual", by looking at past resale history or from standard tables prepared by companies such as ALG. Residual vary by make and model, and by time. The residual value for a vehicle at the end of three years will be less than the value after just two years.
The difference between current value and residual value is called depreciation. This is the primary factor that determines the cost of a car lease. The lease company, who owns the vehicle, is simply getting reimbursed for the loss in value created by the fact that their vehicle is being used by another party.
Some people have asked me if leasing would be free if there was no depreciation -- if a car held it's original value thoughout the lease term. Seemingly, if there was zero depreciation, then the lease should be free.
This is unfortunately not the case. In addition to depreciation there's a form of interest (called money factor in leasing). The lease company used their money to purchase the vehicle from a dealer. That money is tied up in the vehicle and is, in effect, being loaned to the leasing customer. The lease company expects to be paid for the use of their money, just like with any other type of loan.
In summary, car leasing is a special type of financing that is composed of two parts: a depreciation recovery charge and a financing charge (money factor).
Much of the confusion comes from the fact that many people are more familiar with apartment renting and leasing, which are essentially the same thing.
Car leasing is not like apartment leasing. Car leasing is a financing method that is based on paying for the depreciation in value of a car that occurs as it ages and is driven. All cars depreciate in value from the moment they're driven off the dealer's lot.
Lease companies estimate the future resale value of car, called "residual", by looking at past resale history or from standard tables prepared by companies such as ALG. Residual vary by make and model, and by time. The residual value for a vehicle at the end of three years will be less than the value after just two years.
The difference between current value and residual value is called depreciation. This is the primary factor that determines the cost of a car lease. The lease company, who owns the vehicle, is simply getting reimbursed for the loss in value created by the fact that their vehicle is being used by another party.
Some people have asked me if leasing would be free if there was no depreciation -- if a car held it's original value thoughout the lease term. Seemingly, if there was zero depreciation, then the lease should be free.
This is unfortunately not the case. In addition to depreciation there's a form of interest (called money factor in leasing). The lease company used their money to purchase the vehicle from a dealer. That money is tied up in the vehicle and is, in effect, being loaned to the leasing customer. The lease company expects to be paid for the use of their money, just like with any other type of loan.
In summary, car leasing is a special type of financing that is composed of two parts: a depreciation recovery charge and a financing charge (money factor).
posted by Al Hearn at 10:33 PM
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