The Truth About Leasing

Ken Elias
by Ken Elias
the truth about leasing

It comes as no surprise that GMAC and Chrysler Financial no longer offer leases in North America. Ford Motor Credit now joins the "no lease" club by pricing its leases sky high making them unaffordable. Why now? It's simple; the captive finance arms can't get the funding to support these transactions due to the deteriorating credit of the finance arms and their parent automakers.

Let's review. A retail lease transaction represents nothing more than a long-term rental contract of a depreciating asset. The consumer never "buys" – takes title – to the asset; it remains the property of the lessor, the finance company. (When you finance a car purchase, you get the title, the lender has a security interest in the vehicle only until the loan is repaid.) The lessee (that's you!) pays for the depreciation used of the vehicle and the interest costs on the funds advanced by the lessor to acquire the vehicle.

At the end of the lease contract period, the lessee returns the vehicle to the lessor (walks away) or can purchase the vehicle at the stated residual value. This is the so-called "closed end" lease – which is the way all consumer automotive leases are written in the USA.

Leasing makes sense for a certain group of automotive consumers. We won't go into the reasons here; there are plenty of other websites that explain the benefits. But leases also make sense for automakers as well.

First, they put consumers into a revolving door of trading for a new vehicle every few years (typically three to four years). Second, by nature of the math on a lease, monthly payments come in much lower versus traditional financing over the same period. (Heck, even if a car loan is for a longer term that the typical lease term, the lease is usually still cheaper. The break point depends on several factors such as interest rates, residual percentage, and credit quality of the customer.) This allows the consumer to acquire "more" car – which usually has greater profit contribution to the automaker.

Third, subvented leases (a term which means nothing more than "factory dollar support" on a lease contract) hide the incentive spend thus making it look better than a "fire sale" on slow selling units. Luxury brands tend to use subvented leases instead of consumer cash rebates to avoid tarnishing their brands.

Consumers do respond to leases, especially for brands that have high residual values or lots of subvention (hence cheaper leases). You get more car for less money. When you can lease a BMW 328i for less monthly payment than a loaded Chevrolet Malibu on a comparable term loan (assuming zero down on both), which would you choose? (Ok, I hear it now, at the end of the Bimmer lease you own nothing versus having equity in your Chevy – I say, who cares? After four years, do I want a new car or keep driving my now way out of warranty [except for the drivetrain] beater?)

With The Big 2.8 now out of the leasing business, sales will fall even if they come up with more money to support cheaper loan payments (mostly through rate buy downs). Why? Cause some people just like to lease – and the IRS also helps the self-employed who lease by allowing a complete write off of the lease payment (consult your tax advisor).

For GMAC in the first quarter of 2008, leasing comprised 21% of all of GM's retail business in North America. Some portion of those consumers won't come back to GM without a lease program.

While the automakers' captives may point to falling residuals as the reason for exiting the lease market, the real reason is the credit deterioration of the automakers and their captives. Leases generally remain on the books of the captives, they can't be sold into secondary markets in the form of asset-backed securities. So the captives have to fund those leases themselves.

To do so, either the captives generate the funds internally (from profits and existing lease run off) or borrow from others. Well the captives aren't profitable for a host of reasons and leases are definitely unprofitable due to the meltdown of residuals. GMAC's fixed charge coverage in Q1/08 stood at only 0.82 – it didn't generate enough profits to cover its own borrowing costs!

Second, there aren't lenders to the captives who want to see long lived assets of questionable value on their borrowers' balance sheets, especially given the fact that the automakers themselves live on shaky ground.

The captive finance arms of the Big 2.8 cannot support leasing any longer. Sales will be lost as lease customers seek alternatives. No matter what alternative financing scheme Detroit comes up with, it still won't be a lease. So the import competitors now have a choice – raise their own lease rates due to falling supply of available lease product or capture more market share. Hmmm.

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  • Healthy skeptic Healthy skeptic on Aug 02, 2008

    A little late to this argument, but I have to say that buying a used car off of a lease is probably going to be the way to go for me, going forward. That's a good deal. I bought an '01 Jetta GLX fully loaded--leather, premium stereo, heated seats, blah blah blah--back in '04, coming off a 3-yr 30k mi lease, for the same price I could have bought a no-frills new Civic. I found the original window sticker in the Jetta's glove box. I saved a full one-third off, and the car still runs and looks almost like new. (Yes, I'm aware VW products have a bad rep for reliability, but I've never had any problems myself, thankfully.) So the bottom line is, if you really want "more" care than you can afford--go used! Cars are so well made these days as compared to decades past that the "used" stigma doesn't actually have much grounding in reality. This holds especially true for high quality cars like the 3-series Bimmer. Let someone else eat that high initial depreciation, then swoop in and get yourself a nice car for a good price.

  • Simonnorman Simonnorman on Apr 13, 2010

    I hace come accross this post from 2008 and I felt compelled to comment: thank god we're finally out of this credit crunch! There is a good article from Marketwatch that shows that manufacturers have started being quite aggressive about their leasing deals again. See:

  • Olddavid I do not know how to evaluate an automobile any longer. It seems all the selling points valued by the customer base are non-starters in my book. Two tons plus for this vehicle? $50,000 for a Dodge branded Alfa Romeo that cannot sell its heritage to American buyers anyway? Is there any compelling argument for a walk-in to be turned to a buyer by excitement alone? This does not have the ingredients to end well, and that grieves me as I have been a Chrysler fan since they had pushbuttons and slant sixes. Being an elderly me has been difficult lately as I have been a NIssan fan, too, since I first saw that odd Bluebird and we have seen their fortunes edging to free fall territory. What's next? My gramophone breaking?
  • SCE to AUX "maximize commonality on the assembly line"That's code for 'fewer options', which means the manual transmission is done for good. Less tooling, less training, fewer ECU code variants = lower cost and higher quality.I'm sure Ford's new quality guy agrees... or perhaps he thought of it.
  • Carrera Hmm..a Stelantis vehicle made in Italy. What can go wrong? I am sure it will be super reliable, particularly the first 3-4 years of production.
  • Kwik_Shift Manuals are great theft deterrents though. 😉Sad when they're disappearing from many makes.
  • Arthur Dailey Confession here. 2 of the previous generation Rogues in our family over the past 5 years. Saw some cost cutting between the 1st and the 2nd one. On the 'new' one there are no cubbies on the back of the front seats, the ignition is not lit, and there is a marked difference in the front seats. The first Rogue has the most comfortable seats I have experienced since the heyday of the PLCs. Despite sciatica could drive that Rogue for hours with no issues. The seats on the 2nd Rogue create discomfort after 30 minutes. And everyone in the family has noticed this.The first Rogue drove seamlessly. Quiet and comfortable on the highway. On both we have averaged just over 29 mpg. The 2nd Rogue needs to be warmed up and driven slowly if left out overnight in minus 30 (f) or -0 (c) weather, otherwise the engine just revs and the speed does not seem to increase. The dealer has been asked to look at this multiple times but each time they claim that there is no issue. It also has the worst Bluetooth interface I have experienced. Otherwise, based on size, cost, the Rogues were chosen over Toyota/Honda. Both were/are leased so not concerned about long term values/reliability. And the 'new' Rogue came standard with heated seats and blind spot warning, which the Toyota/Honda did not without going up a couple of packages.However we should have bought out the first Rogue when the lease ended. During the height of the pandemic, it could have easily been flipped for close to double the buyout cost.