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Leasing costs a little more
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July 5, 1999: 10:05 a.m. ET
That 'residual value' auto discount from three years ago is long gone
By Staff Writer Alex Frew McMillan
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NEW YORK (CNNfn) - Looking at leasing a car? Don't expect as good a deal as you would have got two or three years ago.
"Those really attractive deals have just become a little bit more expensive," said Rod Couts, executive director of the National Vehicle Leasing Association. "Maybe some of those really good deals out there don't exist anymore."
Consumers can expect to pay about $15 to $20 per month more to lease a car now than the deal they got in 1995 or 1996. And they have fewer places offering leases. Several banks such as First Union and Wachovia have got out of auto leasing the past few months. Nonbank independent World Omni has scaled back sharply. "They're trying to stop the bleeding before it gets too bad," Couts said.
Residual discounts come home to roost
Why? It all revolves around the "residual value" of a lease car, or what it's worth at the end of the lease. The monthly price of a lease has two parts. First is the "rent," mostly the interest on the financing.
The second part is the depreciation of the car, spread out over the lease, normally 36, 48 or 60 months. The lease company takes the cost of a car, minus any down payments, and backs out what it expects it to be worth at the end of the lease, the residual value. The customer pays the difference over the course of the lease.
To attract customers, from late 1994 through 1997 finance companies often overstated the residual value. That reduced the depreciation payments, a so-called "residual incentive." Coupled with a deal on the interest rate, finance companies would reduce leases 10 percent to 20 percent, cutting a $340 monthly payment to $299 perhaps, according to Randall McCathren, executive vice president of Bank Lease Consultants Inc.
But assuming the customer decides not to buy the car when the lease ends, the financier is left with a car that's overvalued. That's what's been happening the last few years. Used-car prices are lagging, making it tough for lease companies to sell cars that are returned.
"Captive" auto finance companies such as Ford Credit Co. and GMAC can write off the residual incentives as a marketing expense. But even the captives are switching their emphasis, facing big write-offs. "Two or three years ago they offered mostly lease incentives," McCathren said. Now they're focused on selling cars. "You get a lot more APR [finance] or rebate incentives," he said.
The big losers as used-car prices dropped have been banks and other independent lessors. First Union and Wachovia stopped leasing in April and July respectively. That followed a spate of banks leaving leasing earlier in the decade, when Marine Midland and Citicorp got out. Analysts say more are looking at getting out of the business.
More banks getting out of leasing
"In the lease business, you don't have control on the back end of the deal," said Bruce Ledwith, who heads Wachovia's dealer-financing division. Twenty percent of the lease cars got returned, and Wachovia couldn't auction them at the right price.
"You can buy the credit, the customer can be great, but if he returns the car to you and it doesn't match up to the residual, you take the loss, at no cost to the customer." Captive lease companies control 70 percent of the market, and that's only likely to grow as more banks get out.
"Every bank is taking some residual loss at this point," said Dick Schliesmann, who heads the auto finance group at Wells Fargo, the fourth-largest bank for auto financing. "It will raise the price of leasing to the consumer." Small cars and compact pickups have really fallen in value, he said. One attractive aspect of a lease is, by returning a car, the consumer doesn't have to worry about that.
But the banks do. The two- and three-year loans are just coming in now, and consumers with five-year leases should hang on to them and count their blessings. Those deals won't be around again. "For a consumer it was very cheap," Schliesmann said. "They were getting a really great deal before."
It's a good question whether banks can really compete, according to Frank McCaughey, a senior vice president at European American Bank. Ford put a very high residual value on the Taurus, for instance, to make it the best-selling car in the country, benefiting from massive sales. Manufacturers can also raise the price the next year. "Independent leasing companies can't compete against that, and banks can't compete with it," he said.
What can you do about it?
The Taurus aside -- Ford was trying to best the Toyota Camry for top-selling honors -- banks are more likely to offer good lease deals on the fastest-selling cars, McCathren said. Manufacturers are less likely to discount them, knowing they can sell them anyway. They typically discount their slower selling models.
It's tough to tell if a lessor is offering a "residual discount." The Automotive Lease Guide, a company that compiles a guide of the same name from a variety of sources, is the best source for residual values, McCathren said. But lease companies may offer a better residual-value deal on cars they think they can resell.
A car with a residual incentive is more likely to be one you want to return at the end of the lease, since it's unlikely to be worth the value the lease company pegged it at. It's worth asking the dealer or leasing company if there's one built in.
For now, "you can generally expect to pay a little more," McCathren said. He said it's important to look at all the factors when shopping for leases, beside the lower payment from a high residual: the early termination charges, mileage allowances, excess mileage charges and so on.
Leasing still has advantages, such as lower monthly payments compared with a car loan. Of course, you don't end up owning the car, but you don't take the chance of its value declining. And leases were artificially low, Couts said. "Manufacturers were just offering in many cases dirt cheap money," he said. "The consumer might not get quite as cheap a deal, is what it boils down to."
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