hought you knew everything about car financing? Think again. Here’s a new spin to the industry you may not yet have heard of: Used car leasing. If low monthly payments are your main concern, this fairly new concept may just be your thing.
As with any new finance concept, however, some caution is in order. In this feature, we’ll take a closer look at used car leasing. We’ll explain what it is, how it works and what its main pros and cons are. And we’ll also compare it to the alternative of simply buying a used car.
After reading this article, you should be able to make up your mind, whether this financing option is for you – or better left alone.
So what is used car leasing?
The basic idea of used car leasing is simple. Over the past few years, leasing has gone from being a niche tool to the fastest growing segment in car financing. According to recent figures, leasing currently takes up about a third of the entire market. This makes it a serious competitor to buying a new or used vehicle.
One of the things that defines a leasing contract is that you’re always getting a factory new car. If you decide to renew the lease at the end of the three year period, you’ll again receive a brand new model. So you’ll always be treated to that wonderful ‘brand new car smell’. And obviously, you’ll also reap the benefits of always having the latest technologies at your disposal.
Used car leasing takes the basic concept of leasing – renting a vehicle at a defined monthly price – and applies it not to new, but used cars. So instead of getting a never previously driven Mini, you may now be getting a three or four year old model. The idea is simple enough. And yet, it has hardly ever been applied in practise.
Why used car leasing may be the future
There is a good reason why used car leasing is slowly edging towards mainstream acceptance and it has everything to do with the related rise in regular leasing contracts. Unless you decide to buy the car at the end of your lease, a dealer will sell it off at an auction. Both sides have something to gain here in theory: You’re getting a new car as part of your new leasing arrangement. And the dealer gets the money from the car sale.
However, with leasing becoming ever more popular, the used car market is swamped with used cars. This has depressed prices considerably. In some cases, it may not even be possible to sell off the car at all. With used car leasing, these vehicles could now be profitably leased to other drivers.
According to the Financial Times, an industry expert has already stated that he expects used car leasing to constitute around 5% of the market very soon:
“It’s only a matter of time before leasing becomes more commonplace in the used car market. I would say it could be a major part of vehicle leasing if it catches on.”
Who can benefit from used car leasing?
As we’ve mentioned, the glut of used cars on the market explains why dealers are keen to push used car leasing. However, it may just work out in favour of customers, too. After all, the main reason for the surge in leasing plans is the fact that they are perfect for anyone with a tight budget. Leasing may be the most expensive form of car financing. But its monthly payments tend to be lowest. In fact, they’re even lower than monthly installments when buying an old vehicle.
If low monthly payments are the decisive factor for choosing leasing over buying, then used car leasing may well be the ideal proposition. Both the value of the car at the beginning of the leasing period as well as its residual value at the end of the lease are considerably lower than those of a new car. So monthly payments will typically be very low. This puts even excellent, prestigious models within reach of a wider audience.
How does used car leasing work?
One of the nice things about used car leasing is that it’s not rocket science. In fact, it basically works exactly like new car leasing:
The dealer first sets the sales price of the car and then estimates its residual value at the end of the leasing period. The difference between these two values is the depreciation for your car. It will form the basis for your monthly payments.
After dividing the depreciation by the number of months of your leasing period, a monthly interest is applied, the so called money factor. The resulting sum is your monthly leasing rate. And it is usually well below what you would pay when buying a new or used car.
Sounds simple? It is. Still, there are a few details you should take into consideration. For one, as mentioned, the sales price and residual value of a used car are below those of a new one. This works to your advantage, as it reduces the monthly payments. At the same time, the money factor will be higher, since financing a used car is always more expensive than financing a new one. This, in turn, works against you, since it raises the monthly payments.
In the end, used car leasing should still be more attractive than new car leasing in terms of finances. However, make sure you have something to compare it against. One way of doing this is to inquire about the details for leasing a new version of the exact same model.
What else is great about used car leasing?
Low monthly rates are not the only thing that is great about used car leasing. As with a traditional leasing deal, you will typically be able to buy the car at the end of the lease. Since its residual value is pretty low, you should be able to get an excellent deal and drive away with your very own car in the end.
Insurance may also be a pro, since the lower overall value of the car typically results in lower monthly installments. Make sure to really do the maths here. Crunch some concrete numbers, instead of simply assuming you will get a great deal.
Many used car deals will also allow you to return the car at any time without prepayment penalties or fees. This is definitely something to consider, especially if you’re facing cash problems during the lease.
Finally, the quality of older cars has steadily improved over the years. This means that although you won’t be able to enjoy that aforementioned new car smell, you should nonetheless be able to get a car that all but feels like new.
The disadvantages & problems of used car leasing
This said, used car leasing is not without its problems. For one, only few dealers will actually offer it at this time. This alone will severely limit your choice in terms of models and brands.
More importantly, everything hinges on the calculations for the depreciation. With a new car, this is not usually a major concern. After all, there are exact figures both for the sales price of the car and its residual value after a given amount of years.
Unfortunately, the same can not be said about leasing a used car. “Unlike a new car, every used vehicle is unique, with a unique payment and residual”, industry expert John Possumato writes. Although forecasting models have greatly improved, this poses a problem. According to Consumer Reports:
“Another risk with used-car leasing is that it’s difficult to predict what that car will be worth when it’s, say, five years old. There is a great deal of variation in the five-year-old market. But that knowledge is necessary because your monthly payments hinge on its supposed retained value. If the dealer sets it too low, your payments will be higher than they need to be. If he or she sets it too high, it gives him or her latitude to push up the car’s initial price while offering what seem to be acceptable monthly payments.”
And this is just the beginning. An even bigger issue with used car leasing is that you’re no longer covered by warranty. After all, most vehicles will be more than three years old. This means that the costs of every single repair that needs to be performed will have to be paid out of your own pockets. In the words of howstuffworks: “Leasing a used car could mean spending money at the dealership to repair a car that ultimately belongs to the dealer.”
If statistics are to believed, three year old cars have double the amount of problems as a one year old model. So costs can quickly add up.
How to get the most out of used car leasing
Although used car leasing is not without its issues, there are a few things you can do to mitigate its negative aspects.
By selecting a car with an excellent resale value, you can reduce the depreciation, resulting in lower monthly payments. Of course, should you wish to purchase the car at the end of the contract, a lower residual value may instead be more desirable.
The other vital point is to definitely get a warranty for the leasing period. Without it, you run the risk of having to pay more than the actual purchasing price of the car. At worst, you may no longer be able to afford monthly payments. A warranty may seem like a costly item, especially if you’re pressed for cash. But with used car leasing, it is usually worth it.
You should also make sure that you won’t be exceeding your mileage limit. Every additional mile will cost you dearly. So either buy extra miles at the beginning of the leasing period, when they’re cheaper – or buy a used car instead.
Finally, you should devote ample time to researching the car you intend to lease. As we’ve mentioned before, used car leasing is not (yet) an exact science. So everything depends on preventing unwelcome surprises. You can get a vehicle history report for as little as 20 Pounds. In the light of what we’ve just written, that looks like well spent money.
Used car leasing versus used car buying
So is used car leasing worth it? As always, it depends. If you only have a very low, fixed monthly sum at your disposal, used car leasing may be your only option, since it keeps the monthly payments at an absolute minimum. With used car quality constantly improving, you may enjoy a repair-free leasing period and buy off the car from the dealer at an affordable price.
In the ideal scenario, therefore, used car leasing looks like a more than welcome addition to the finance sector.
Overall, however, buying a used car is clearly the better option.
For one, buying a car is always cheaper than leasing it. In fact, even buying a new car is usually cheaper than leasing a used one on a long enough timeline. And obviously, you get to enjoy all the benefits of actually owning a car instead of just renting it.
Used car leasing is definitely an interesting model. Just be sure to think things through very carefully before committing to it.