Pre-paid Car Lease. Single-Payment Lease. Smart or Not?

Pre-paid, or single-payment car leases are often an option for people who have available cash. It promises to eliminate payments and save money.

However, is it smart to pay everything up front to avoid monthly payments? Are there drawbacks? Do you actually save money?

Not quite what is seems
Car leasing normally involves making low monthly payments over a specified term of months. Like a loan, these payments contain financing charges. Paying cash for a car avoids these finance charges.

At first glance, it appears that pre-paying a car lease with cash might also eliminate finance charges, or interest, like with a loan. However, this is not quite true. Leasing works a little differently, 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 it works
First, let's examine what you actually pay in a pre-paid car lease. You pay the depreciation portion of your lease and you pay the total interest on the residual portion.

Therefore, you save some finance charges, but not all. You still pay interest on the residual amount (as part of your single payment), because you are, in effect, borrowing the amount of the lease-end residual value for the entire term of the lease, and paying it back only when you return the vehicle at the end of your lease. Part of your borrowed money (the residual value) is "locked up" in the vehicle and can't be pre-paid.

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. You pre-pay those finance charges in your single up front cash payment.

You pay off the remainder of your lease 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
Your actual interest savings may be much less than you might have expected, especially in a shorter term lease. You avoid some interest, but must pre-pay some too.

Actually, the way that some lease companies calculate your single payment (simply as the sum of all monthly payments), you save nothing on interest, 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 pre-paid lease, ask your lease company how they compute it and if you save money on some of the interest.

Second, most lease companies will report your lease as a lease or loan obligation on your credit report even though you are pre-paying part of your lease (everything except the residual). Most lease companies will report your lease-end residual as the loan/lease balance. Pre-paying a lease is not the same as pre-paying a loan or rental.

Another consideration
There is a possible disadvantage to sinlge-pay leases that should be considered. 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.

Contrast the above total-loss situation with a normal monthly payment lease. The lease company (in most leases) picks up financial responsibility for the difference between what you still owe on the lease and the insurance settlement. This is known as "gap" coverage and is automatically included in most leases. You would lose nothing except your insurance deductible.

Gap coverage, even if included in your pre-paid lease, provides no benefit to you. It does not cover your cash losses.

Summary
In summary, single-pay pre-paid leases offer benefits of no monthly payments and a modest savings in finance charges (depending on how your lease company calculates the single payment), but carries the risk of possible loss if the leased vehicle is stolen or destroyed. It might make more sense to use the cash for other, more productive and less risky purposes.

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