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4 Things to Know About Equity (and Your Leased Car)

Equity can be a confusing topic, and adding leasing into the mix makes it even more complicated. But it’s worth learning about, because it can work for – or against – you. Below, we’ll go over what exactly equity is and how it’s calculated. We’ll also show you why you should care about the potential lease equity in your car, along with the benefits to unlocking and accessing that equity. Ready? Let’s review 4 essential things to know about equity and car leasing.

1. What is equity?

Equity is the portion of an asset (like a house or car) that you ‘own’. That’s a bit of an oversimplification, but it works to start.

Think of an asset, like a house. Whoever owns it likely has – or at one point had – debt that was used to purchase and own it. (For homeowners, that debt is a mortgage.) Generally, the goal is to pay that debt off and own the asset entirely. But that might take a long time, or the asset may even be sold before then, so we need a way to describe ownership of the asset along the way.

A better definition of equity is what you’d be left with if an asset was liquidated (or sold) and any/all debts were paid off.

Let’s say you’ve bought a house, with a mortgage, for $500,000. If you eventually pay off $200,000 of the mortgage and then sell the house for $500,000, you have $200,000 of equity in the home. How? You got $500,000 from the sale, had to use $300,000 of that to pay off the rest of your mortgage balance, and are left with $200,000.

The thing is, assets (especially homes) rarely sell for exactly what you initially paid. We’ll circle back to this – and why it matters – in a sec.

2. Isn’t equity just for things you own or finance – not something you’ve leased?

This is a bit of a trick question, because leasing a car is a form of financing (that’s why you have an APR on a lease). If you didn’t know that, you’re not alone – according to Lease End CEO Brandon Williams, one of the biggest misconceptions that consumers seem to have about leasing is whether “they own the vehicle or not.”

Let’s say you’re looking for a 3-year lease. When you lease, the manufacturer (Toyota, Honda, etc.) is lending you a car for the cost of driving it for 3 years. (This whole transaction is facilitated through a dealership, who often marks up the transaction.) The cost of driving the car is the depreciation of the car over those 3 years – in other words, the amount of value that the car loses during those three years of use, wear-and-tear, and mileage.

So, similar to equity in a home you’ve financed, you can build equity in a leased car. Let’s say the lender decided that, over the course of your lease, you’d need to pay $25,000 for 3 years of the car’s life (in addition to fees and interest that the lender adds). If you’ve paid $12,000 on your lease so far, you have $12,000 of equity in that car.

3. Why should I care about the equity in my leased car?

Title: Top 10 Car Lease Buyouts with Highest Average Equity (By Make) from the Lease End 2022 Roadmap Report. Depicts a descending bar graph with the following information about highest average equity for a lease buyout with the following manufacturers, through Lease End. Honda’s average was $8221; Hyundai’s was $7560; Toyota’s was $7275; Subaru’s was $7199; Kia’s was $6647; Jeep’s was $6031; Nissan’s was $5989; Ford’s was $5633; Volkswagen’s was $5546; and Chevrolet’s was $4598.

Let’s talk about homes again for a second. Remember – you’ve got a home that you “paid” for (with a mortgage) for $500,000 – and you’ve paid $200,000 of that mortgage off, so you have $200,000 of equity in the home. 

That amount you’ve paid off will stay consistent (until you pay more off, obviously). The home’s value can change, though – and this can be good or bad, depending on the market. 

Think of someone who bought a house for $500,000 but could only sell it for $400,000. Even if they pay off the full $500,000 mortgage by the time they sell it for that price, it’s like they’re losing money. They’ve invested $500,000 – their equity – into the home, but only got $400,000 back for it. This is, of course, is why people don’t like to sell their houses for less than they paid for it. But it works the other way around as well. If you’ve bought a house for $500,000, paid it all off, and end up selling it for $700,000, you’ve made money off that $500,000 investment. That’s the position everyone wants to be in. 

Let’s apply this to leasing now. 

Let’s say you’ve leased a car with a $35,000 MSRP (Manufacturer’s Suggested Retail Price). That’s more or less how much you’d pay (or finance) to buy the car and own it, plus fees. However, if you’re entering into a 3-year lease term, you don’t need to pay the full price of the car – you just need to pay for the cost of 3 years of the car’s life (in other words, 3 years of depreciation) plus leasing expenses.

How does this break down into your lease payments? The lender takes the MSRP and then estimates how much the car would be worth at the end of your lease period. Let’s say that in this case the MSRP is $35,000, and the lender estimates that the car’s worth after the 3-year lease – or, the residual value – is $21,000. That would mean that you only need to pay $14,000 over the course of the lease to cover that depreciation, right? 

Not quite. In addition to markups that cover maintenance, incidentals, and the leasing process, your lender factors interest into your lease payments (because you’re financing the lease). These additional costs are a big reason why many people choose not to lease—because you’re paying for the depreciation of the car and then some. 

So let’s say that, with those additional costs, you pay closer to $20,000 over 3 years to drive that car. At the end of that lease term, you’ve paid everything in full – basically, you’ve invested $20,000 into the car. What’s important now is the car’s current market value. Generally, lenders make their depreciation estimates pretty accurately. But if they guess wrong, you could actually make money off your lease. 

Generally, you have two options for ending a lease – turning it back in to the dealership, or buying it out (and then keeping or selling it). If your lender was right on the money, and your car’s market value is $21,000 when your lease is over, you might be more inclined to just turn the car back in.

But let’s say your lease-end rolls around, and after some browsing online, you find out that the car you’ve been leasing – with similar mileage and condition – is currently going for around $28,000. If you turn the car back in to the dealership, they could sell that car at that price – or more – and get money back on an investment that could have been yours.

The thing is, you can access that equity, too. If you buy out your leased car for $21,000 – the residual value of the car – you could sell it for $28,000.

BuyoutProfitPieChart-1

So, let’s review the numbers one more time. The car you leased was valued at $35,000 brand-new, and you’ve paid $20,000 over 3 years to drive it. That $20,000 is equity you’ve put into the car – you’ve basically invested $20,000 into driving that car. 

When you reach the end of your lease, it may feel tempting to just walk away – after all, buying out a leased car is just spending more money, right? But if you don’t buy out a leased car, you’ve just spent $20,000 on an asset you don’t – and won’t – own. Assuming you’ll still need a car at the end of your lease, you have the option to buy a brand new car, try and find a good deal on a used car, or keep the car you’ve already been driving at an (often) below-market price. Buying out your leased vehicle means taking advantage of the equity you’ve already invested into your vehicle – without starting over from scratch. 

So how exactly can you do that?

4. How can I unlock and access that equity?

Lease buyouts are key to fully accessing lease equity in a car – there’s really no other way to get it. Although you can build equity in a car while you’re leasing it (and don’t technically own it), you will need to own it to actually take advantage of that equity. 

To learn about how exactly a lease buyout works, you can read more here. For now, we’ll keep it simple and say that a lease buyout means you’re purchasing the vehicle from the lender (who holds the title of the car throughout the lease) for a pre-determined price that’s established in your leasing contract. 

This pre-determined price is that lender’s estimate (the residual value) for how much the car would be worth at the end of the lease. If the buyout amount is a little – or a lot – above your budget, you can get a loan for that buyout amount through Lease End

Once you’ve bought out the vehicle, it’s yours, so you can sell it and make a little extra cash, or keep it for yourself. If you keep it, you won’t get your positive equity as cash-in-hand, but you will be ahead of the curve by only financing, say, $21,000 for a $28,000-value vehicle. You’ll keep making monthly payments just like you have been – except this time, you own the car (and your payments may even be lower than they were during the lease).  

To Lease End COO Zander Cook, “…the biggest [myth about leasing] is that you have to go back to the dealership to end your lease.” We want drivers to know that they have options – options that save both time and money. Get started by entering your VIN or license plate below, or by calling (877) 425-0460 to get started with a lease-end expert. Visit leaseend.com to learn more and try our Monthly Payment Calculator for free.

 

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