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How does Leasing REALLY Work?

To understand how a lease works we should first look at how a regular financing plan works.

Lets say (for easy math) that you purchased a vehicle for $30,000. You would be required to pay the sales taxes up front as part of your purchase. Since taxes vary between states and provinces we will use 12% for our example. Your total would be $30,000 plus 12%, which adds up to a total balance of $33,600 to start your loan.

You would pay off that amount a little bit each month over a period of four to five years until your loan is paid to zero.

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Now lets look at how a lease works. Since you are buying the same vehicle the sales price will be the same $30,000.

The biggest difference between a purchase and a lease is when you go to register the vehicle; you will be registering it to you and the leasing company.

Since technically you don't own the vehicle yet, you are not required to pay the sales tax yet. You are only required to pay the taxes on the money you have put towards the vehicle. So say you put a $1,000 down payment on the vehicle, that would be like you bought $1,000 worth of the vehicle and would only be responsible for taxes on that amount.

So at our example of 12%, you would only have to pay $120 in tax up front rather than $3,600 that the person buying the vehicle would have to pay.

Assuming that you don't put money down, your lease will start at $30,000 compared to the $33,600 for traditional purchase financing.

Another difference between a lease and a purchase is that rather than paying the loan to zero, you will pay the $30,000 down to a lump sum determined by the leasing company.

This lump sum amount will be determined depending on the type of vehicle you are considering and the number of years you will be leasing for. For the purpose of understanding how a lease works, the exact amount really doesn't matter, so lets say the lump sum amount is $14,000.

You will be required to pay the $30,000 down to $14,000 over a certain period of time.

This means your payment will be based on the $16,000 you are paying off over the course of the lease. And since each month you are buying just a little bit of the vehicle you are required to pay the sales tax on only that amount.

So if you had a $350 payment, that would be like you were buying $350 worth of the vehicle and you would be required to pay the 12% only on the $350 each month.

Now comes the best part about a lease. It's not about lower payments (although that's usually a nice side effect). It's about what happens at the end of the term!

Buy

Since you have paid the vehicle down to $14,000 that will be your purchase price.

If you love the vehicle and can see yourself driving it for the next few years, great, just pay the remaining $14,000 plus the sales tax on that part and keep it. After all you know the vehicle better than anyone.

Sell/Trade

Peoples needs or wants change over time, things like marriage, babies, new homes, new jobs, retirement all factor in when it comes to what type of vehicle you drive.

Maybe you don't want the vehicle any more, you may have no need for it or would just like something different.

A lease allows you to take a step back, three or four years later, giving you the opportunity to re-think and re-evaluate your current needs.

Protection

However, if the markets change (and they do change) and your vehicle depreciates faster than expected, the value may be less than the $14,000 you paid it down to.

STAY CALM! This is the best part about a lease.

Your obligation to the leasing company ends with the term of the lease. As long as you are within the mileage that was set at the beginning of the lease term and do not have any excessive wear or excessive damage to the vehicle, any depreciation beyond $14,000 is not your responsibility.

Simply return the vehicle to the leasing company and start again. Also, because you haven't purchased the entire vehicle yet, you are also not responsible to pay the taxes on the remaining $14,000. In this case at 12%, that is $1,680 you never had to invest in the vehicle.

Top Three Leasing Questions and One Bonus Answer

There are certain questions that almost everyone wants to know about leasing.

1) Can I sell or trade my car anytime?

Yes, like a bank loan every payment you make is paying the balance lower and lower. So, if you decide to sell/trade your vehicle you can do that by paying out the entire remaining balance.

When you sell/trade your car early, your vehicle may have depreciated faster than what you have paid for to that point, so any extra depreciation is your responsibility to either pay for up-front or build into your next payment.

Many people mistake the extra depreciation as an early termination penalty or fee. However, not every lease is created equal, so it is important to check what kind of interest penalties or early payment fees may apply. Many leases do not apply penalties and will even give an interest break for paying out early, just like a bank loan.

2) Can I give it back anytime?

Yes, but you are still required to finish your obligation to the leasing company. If you give it back early you are still responsible to make the remaining payments on the lease (some companies will give you an interest credit for paying out early).

If you do not pay this you will be in default of the terms of your lease, which would be reported to the credit bureaus, damaging your credit.

3) How can I get out of a lease early?

To get out of a lease early you can apply any of these options:

  • You can buy it out to keep it by paying the remaining balance and taxes.
  • You could trade/sell the vehicle by paying out the remaining balance and taxes, keeping any value above the payoff amount or making up any shortfall below the payoff amount.
  • Give the vehicle back and pay the remaining obligation.
  • Have someone assume your lease payments.
How does a lease assumption work?

A lease assumption can go by a few names, Lease Assignment, Lease Transfer, Transfer of Liability, etc.

Basically if you had a friend, family member, neighbour, or anyone you could find that would want to drive your vehicle and make your payments, they can apply to take over your lease and if approved they would step in and you would step out freeing you from any further obligation.

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