4/24/2008

So I received an email from a reader explaining the whole down payment dilemma in a very detailed and extremely convincing manner. It has, changed my view of down payments. I’m not saying I’d put down a large down payment, but if you got it, why not, specially if the interest is high on the vehicle you plan on leasing. Also, I do recommend everyone to call their insurance agents and find out how their policies treat leases.

So here are excerpts of the email sent by Damien from D.C.

“So I called my insurance company, Geico, and asked them about it. They report that their payout for a claim doesn’t rely on how the car was financed. That is, if they determine it is a $27k payout and residual value is $20k and you owe nothing, then you would get your $7k in cold hard cash.

I think what you are giving up is the GAP protection. In our example, you lost $3k. That would be the maximum you could lose, because there are no remaining lease payments and therefore there is no gap to protect.

Look at the other direction, where you pay $1000 to drive off the lot. In this case, your remaining lease payments are around $11k. The residual + the remaining lease payments is $29k, and the insurance company pays off $27k. This leaves a $2k gap, which the lease (if it includes GAP protection) would cover. In this case you only lost $1k, not $3k.

So it is a gamble, but not for the down payment amount. The gamble is for the gap, or depreciation. The depreciation is the highest when you drive off the lot, and should be $0 after your last lease payment.”

There you have it folks, I couldn’t have said it better myself. Props to Damien for this insightful email.
Now I gotta call my insurance agent tomorrow 😛

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Lately, I have been putting a lot of thought into the down payment. Generally, I don’t advise people to put down a lot for their initial drive off costs since in the event the car is stolen/totalled, you will lose all that is put towards the car. That typically happens because GAP coverage from either your insurance or the leasing bank only covers your remaining payments. However, I have been analyzing the financial effect of paying a down payment and it makes a lot of sense (assuming you never get your car stolen or totalled). Take this for instance, lets say I want to lease a vehicle that at a cap cost of $30,000. The residual value is $18,000 (60%) after 36 months This would mean your depreciation fee you are paying is 12,000, which you will finance at a rate of say .00101 or 2.42%, then of course, you pay your sales tax every month. Now lets say you put down 10,000 dollars, lowering your cap cost to $20,000, which makes your effective depreciation fee $2,000. This pretty means that you are being charged interest and sales tax on $2,000 versus $12,000, saving you a bunch over time.

Of course all of this comes at a risk. Get the car stolen or totalled in an accident, you lose the $10,000 in a flash. So, are you the gambling type?