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Pre-paid Car Lease. Single-Payment Lease. Smart or Not? |
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Prepaid, or single-payment car leases are often an option for people who have available cash. It promises to eliminate monthly payments and save money. Such leases are sometimes called one-pay leases. However, is it smart to pay everything up front to avoid monthly payments? Are there drawbacks? Do you actually save money? What are the pros and cons? Not quite
what is seems At first glance, it appears that pre-paying a car lease with cash might also eliminate all finance charges, or interest, which would save significant money. However, this is not quite true. Pre-paying a lease works a little differently than pre-paying a loan, as we will see below. Some people also believe they can avoid having a lease appear as a new debt obligation on their credit report by "paying off" the lease up front. This is not quite true either. Furthermore, pre-paying a lease defeats one of the primary benefits of leasing — to minimize use of hard cash so that the cash can be used for other, more productive, purposes. However, before we draw conclusions about whether prepaid leases are smart, let's take a closer look at how a one-payment lease works and what benefits it may or may not provide. How a one-pay
car lease works You do not pay for the entire value of the vehicle, as you would if you were pre-paying a loan (paying cash). You only pay the depreciation portion of your lease — and you pay the total interest on the residual portion. You avoid paying interest on the depreciation portion. For more about how lease payments are made up of depreciation and finance charges, see Monthly Lease Payments. Let's say it in a little different way. When you "pay off" a lease you're not really totally paying it off. You pay off everything except the lease-end return value (residual value). Finance charges still apply to that amount. Although you don't avoid those charges, you can pre-pay them in your single up front cash payment. You pay off the remainder of your lease "loan" when you return the vehicle. Even though you don't make monthly payments, there are still finance charges on the value of the vehicle while you "borrow" that vehicle during your lease. What you save
with a single-pay car lease Actually, the way that some lease companies calculate your single payment (simply as the sum of all monthly payments, including interest), you save nothing on finance charges, since interest is included in each monthly payment. This is obviously to the lease company's advantage and would be unnoticed by most leasing consumers. So, if you are considering a prepaid car lease, ask your lease company or dealer how they compute it and if you save finance charges on depreciation charges. Be aware that most dealer sales people don't completely understand leasing and might simply give you the answer he thinks you want to hear. Ask the dealer's Finance Manager instead. Ask the manager to compute your lease with monthly payments and without (pre-paid). If your pre-payment amount is the same as the sum of monthly payments, you are not saving any money with this dealer. Next, you can save some sales tax when pre-paying a lease. In most states, sales tax is added to monthly lease payments. But monthly payments include both a depreciation payment and interest. It may not seem fair but you pay sales tax on that interest. If you eliminate that interest by pre-paying your lease, you avoid paying sales tax on it. You still pay sales
tax on the depreciation amount in your single payment, however, but the
total sales tax paid is less than if you made monthly payments. Those lease companies who report your lease will
report the lease-end residual as either a loan or lease balance. The amount will stay on your credit report as a debt for the duration of the lease, until you either return the car at lease-end or purchase it from the lease company. Since you'll be making no monthly payments, there will no payment history associated with the debt, which in not a problem but it doesn't help build your credit score either.
A possible
disadvantage of pre-paid car leasing If your car should be stolen or destroyed in an accident, your insurance would pay only the current market value of the vehicle, not the total amount you have invested in your lease. You would stand to lose a large chunk of your up front cash payment, the same loss you would incur if you had paid cash for your car. Contrast the above total-loss situation with a normal monthly payment lease — no pre-payment and no down payment. The lease company picks up financial responsibility for the difference between what you still owe on the lease and your insurance settlement. This is known as "gap" coverage and is automatically included in most leases. You would lose nothing except your insurance deductible. This is one of the good benefits of car leasing with little or no down payment. Gap coverage, even
if included in your pre-paid lease, provides no benefit to you. It does
not cover your cash losses. This risk is greatest in the early months
of a pre-paid lease, and lessens as the lease nears its completion. Make your decision about a single-payment lease knowing and understanding the benefits and the risks.
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