What is a Single Payment Lease and How Does it Work?
Does a pre-paid car lease save money?
Single-pay car leases (also called pre-paid leases) are often an option for people who want to lease and have the cash to completely pay off the entire lease amount up front. It eliminates monthly payments and might save money. Such leases are sometimes called one-pay, or simple-pay leases, depending on lease finance company.
However, is it smart to pay everything up front to avoid monthly payments? Are there drawbacks? Do you actually save money?
What are the pros and cons?
Car leasing normally involves making low monthly payments over a specified term of months. Like a loan, these payments contain financing charges.
At first glance, it appears that pre-paying a car lease with cash might also eliminate all finance charges, or interest, which would save significant money. However, this is not quite true. Although it may eliminate some charges, pre-paying a lease works a little differently than pre-paying a loan, 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 also not true.
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 wise, let’s take a closer look at how a one-payment lease works and what benefits it may or may not provide.
How a one-pay car lease works
Before we get started, we want to point out that different lease financing companies may compute single-pay leases differently. There is no single standard method used by all lease companies, but it’s usually done in one of the following two ways.
Pre-Paid Lease Method 1 – With this method, which is best for the customer, not best for the lease company, you make a single payment that pays for the cars depreciation over the lease term, sales tax on that amount, and the sum of all remaining monthly payments. See our example below.
This means you do not pay for the entire value of the vehicle, as you would if you were pre-paying a loan (i.e., paying cash). You only pay the depreciation portion of your lease (plus sales tax) — and you pay the total interest on the residual portion. You avoid paying interest on the depreciation portion, which is roughly half of the total interest on a 36 month lease.
For more about how lease payments are made up of depreciation and finance charges, see Monthly Lease Payments.
Therefore, with this method, you save some finance cost, but not all. You still pay interest on the residual value (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 in advance.
Pre-Paid Lease Method 2 – This method is more common — because it’s more profitable to the dealer and lease company — and it’s easier to compute. Since a dealer’s “captive” finance company controls how leases are handled, it’s not normally negotiable as to which method is used to calculate pre-paid leases.
With this method, your monthly payment is calculated in the normal way (see Monthly Lease Payments), including sales tax, and assuming $0 cap cost reduction. That payment is then multiplied by the number of months in your lease (lease term), which gives you the amount of your single up-front payment. See our example below.
You save no money with this method, either on finance charges or sales tax, although you might get a discounted money factor (because of your large “down payment”), which does provide savings.
You still need good credit to get approved for a pre-paid car lease
Since a single-payment lease is still a financial obligation, you still need a good credit score. However, you might be able to get by with a lower score since you are pre-paying a significant portion of that obligation. You should know your credit score before you attempt a lease to avoid a surprise rejection. What’s your FICO score? Find out now when you check your credit report for $1 at Experian.com!
Contrary to some belief, pre-paying a lease doesn’t boost your credit. However, since you make only a single payment, there is no chance of a “late” or “missed” monthly payment. It also remains on your credit report as a debt obligation until you return the car which, in effect, is the final payment on the lease.
How about money factor – do you get a better finance rate?
Pre-paying a car lease is, in effect, making a huge cash down payment. Many lease finance companies offer lower finance rates (money factor) for such leases. If you have poor credit, a single-pay lease may allow you to be approved for a lease for which you might not otherwise qualify.
Don’t forget to negotiate your best price
Price is the most important factor in a lease over which you have some control. When leasing, even a modest price reduction has a much greater effect — in lowering monthly payment — than a similar reduction when buying. In fact, it’s important to bargain for your best price before discussing single-payment arrangements — before too many confusing numbers begin flying around.
One of the most useful things to know when negotiating car prices is to know what other people are paying for the same car you want. Otherwise, you likely won’t know what price you’re negotiating for, especially if there are hidden incentives available. You can easily get this information at Edmunds, an invaluable resource for anyone buying or leasing a car.
Is it worth it? You decide
If your dealer and finance company use Method 1 above, you can save money on interest and sales tax with a one-pay lease. Your actual interest savings may be less than you might have expected, however, especially if you are leasing a car with a relatively high residual value. You avoid some interest, but must pre-pay some too.
If your dealer uses Method 2 above, the way that some lease companies calculate single payment leases (simply as the sum of all monthly payments, including interest and tax), you may save nothing except the hassle of making monthly payments.
So, if you are considering a prepaid car lease, ask your lease company or dealer how they compute it and if you save some finance and tax charges. Be aware that most dealer sales people don’t completely understand leasing and might simply give you the answer he thinks you want to hear. Ask the dealer’s Finance Manager instead. Ask the manager to compute your lease two ways: with monthly payments and without (pre-paid), assuming $0 cap cost reduction. If your pre-payment amount is the same as the sum of monthly payments, you are not saving any money.
Examples – Compute a pre-paid lease using both methods
Method 1 Example: Let’s say the negotiated net capitalized cost (cap cost) of your new car is $40,000 and the lease-end residual value is $21,000 for a 36 month lease. The “depreciation value” on this car is $40,000 minus $21,000 = $19,000. As part of your single-pay lease, you pay the $19,000. You may also have to pay sales tax on that $19,000 depending on the state/county in which you live. If the rate is 6%, for example, the tax amount would be $19,000 x .06 = $1140.
Now, you’re left with the interest on the residual value, which is computed as Residual Value times 2 (see this article for explanation of lease formula) multiplied by Money Factor. With a Money Factor of .00238 (5.7% APR) this comes out to be $100/month. In most states, you must add sales tax to this amount (yes, we know it doesn’t make sense to tax finance charges but that’s the way state laws work). If your local tax rate is 6%, then the total computed monthly payment would be $106. Since you want to pre-pay this amount, multiply $106 by 36 months to get $3816.
So, your total lease pre-payment using Method 1 is $19,000 (depreciation payoff) plus $1140 (sales tax payoff) plus $3816 (residual finance charge payoff) = $23,956.
Method 2 Example: Same car as above, same price, same residual, and same money factor. In this example, the lease payment is computed (see Lease Calculator) assuming $0 cap cost reduction to be $673 + $32 tax = $705. Multiply by the lease term (36 months) to get $705 x 36 = $25,380 as your single lease payment.
The savings difference between Method 1 and Method 2 above is $25,380 minus $23,956 = $1424. For a $40,000 car, this savings difference is not very significant.
It may be more useful to look at the cash purchase amount for this car, $40,000 plus $2400 tax = $42,400 compared to the highest single-payment lease amount of $25,380 — a significant cash outlay difference, both with no monthly payments.
A variation of the single-pay lease
If you have a paid-off trade-in vehicle that has enough remaining value to cover the cost of a single-pay lease, you can trade your old car and drive a new car for 3 years with no monthly payments. Depending on the value of the trade vehicle and the cost of the new vehicle, you may actually get money back — or have to pay some extra– or break even. And in most states you avoid much of the sales tax on the new car (most states give you tax credit for trade-in vehicles).
Your credit report and pre-paid leases
Most lease companies will report your lease like an installment loan obligation on your credit report even though you are pre-paying part of your lease (everything except the residual). Some might report it as a satisfied debt. Others might not report it at all, like a cash purchase. It depends on your lease finance company and their particular way of handling lease reporting to credit bureaus.
If the lease finance company reports the lease, the lease-end residual amount will stay on your credit report as a debt for the duration of the lease, until you either return the car at lease-end or purchase it from the lease company. Since you’ll be making no monthly payments, there will no payment history associated with the debt, which is not a problem but it doesn’t contribute to helping build your credit score either.
A possible disadvantage of pre-paid car leasing
There is a possible disadvantage to single-pay car 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 — the same loss you would incur if you had paid cash to purchase your car.
Contrast the above total-loss situation with a normal monthly payment lease. If you total your car, the lease company picks up financial responsibility for the difference between what you still owe on the lease and your insurance settlement. This is known as “gap” insurance and is automatically included in most leases. You would lose nothing except your insurance deductible. This is one of the benefits of leasing a car using little or no down payment cash.
Gap coverage, even if included in your pre-paid lease, provides no benefit to you. It does not cover your cash losses — exactly the same as if you purchased your car with cash. This risk is greatest in the early months of a pre-paid lease, and lessens as the lease nears its completion.
In summary, if your intention is to save a significant amount of money with a pre-paid lease, neither of the two common calculation methods does it for you. Depending on the car make/model and price, the difference between the two methods might be only $1000-$3000.
The benefits provided by both methods are: 1) much lower cash outlay than purchasing the same car, 2) no monthly payments, 3) possible lower money factor, and 4) the option of returning your car at lease-end to get another new car without the hassle of disposing of a used car.
Make your decision about a single-payment lease knowing and understanding the benefits and the risks.