FRB: Vehicle Leasing: Leasing vs. Buying: Early Termination

	Glossary
Leasing vs. Buying Early Termination

Leasing	Buying
You are responsible for any early termination charges if you end the lease early.	You are responsible for the payoff amount if you end the loan early.
Disclosure requirements. Early termination means that the lease ends before the scheduled termination date for any reason, voluntary or involuntary. The federal Consumer Leasing Act requires the lessor to state the conditions under which a lease may be terminated early and the amount, or a description of the method for determining the amount, of any penalty or other charge for early termination.	Disclosure requirements. A loan can end before the scheduled completion date through either early payoff or default. If you prepay your loan, you may have to pay a penalty, or you may be entitled to a refund of part of the finance charge. The federal Truth in Lending Act requires the creditor to state whether a penalty will be imposed and whether you are entitled to a rebate.
Early termination option. Voluntary termination means that you choose to end your lease before its scheduled termination. Most leases give you the option of ending your lease early. In most leases, you may turn in the vehicle, pay the balance due (including any associated early termination and other costs), and end the lease. Some leases permit you to terminate early only if you purchase the vehicle.	Payoff option. Voluntary payoff means that you choose to pay your loan in full before the end of the scheduled term. Most finance agreements give you this option.
Involuntary termination. Involuntary termination means that the lease ends early for reasons unrelated to a voluntary termination, such as when the vehicle is stolen or totaled in an accident. You may have gap coverage to pay some or all of the deficiency owed in this case. A default, which means that you fail to meet one or more conditions of your lease agreement, may also lead to early termination.	Involuntary termination. Involuntary termination means that the loan must be paid off early for reasons unrelated to a voluntary payoff, such as when the vehicle is stolen or totaled in an accident. In this case, your insurance may cover some or all of the payoff amount owed. Involuntary termination may also include default, which means that you failed to meet one or more conditions of your loan agreement.
Calculation of early termination charges. If your lease ends early, you may have to make a payment (early termination charge) to satisfy your lease obligations. This payment may be substantial. The early termination charge is typically the difference between the remaining balance on the lease and the amount credited for the vehicle (realized value of the vehicle). This calculation is set forth in the lease. Usually, the amount credited will be the actual wholesale price received for the vehicle or a wholesale value established by some other means, such as an independent appraisal. In addition, the early termination charge may include charges such as fees for disposal of the vehicle, transfer fees, and taxes. In virtually all cases, you must pay other amounts owed, such as late charges, past-due monthly payments, and parking tickets. Some lessors also charge an additional amount, usually a fixed dollar amount, to reimburse their costs of early termination and the portion of their initial costs that would have been covered by the remaining rent charge. Amount of early termination charge. The earlier you end your lease, the higher the early termination charge is likely to be. The charge may be up to several thousand dollars and may exceed the amount you would have paid if you had completed the lease. Thus, because early termination may be expensive, you may want to select a lease term for the length of time you plan to drive the vehicle instead of choosing a longer term (to get a lower monthly payment) with the idea of terminating the lease early.	Calculation of loan payoff amount. To pay your loan in full before the end of the scheduled term, you must pay the loan payoff amount. In virtually all cases, you also must pay other amounts owed, such as late charges and past-due monthly payments. The loan payoff amount may be more or less than the trade-in or market value of your vehicle. If you prepay your loan during the first half of the loan term, it is likely that your loan payoff amount will be more than the market value of your vehicle, unless you made a very large down payment.
Reasons for early termination charges. A large part of your early termination charge is due to the fact that the wholesale market value of a vehicle declines more quickly at the beginning of the lease. In the early part of the lease, the amount you pay for depreciation does not fully cover the amount the vehicle actually depreciates. So if you end the lease early, there will usually be a shortfall. As the lease nears its end, this shortfall is generally lower because more of your payment is allocated for depreciation. In a closed-end lease, at the end of the lease, if you have made all of your payments, you are not responsible for any shortfall between the depreciation you have paid and the actual vehicle depreciation.	Reasons for payoff deficiency. A payoff deficiency exists when the actual vehicle depreciation exceeds the principal paid, plus any down payment. The shortfall usually occurs because the market value of the financed vehicle declines more quickly at the beginning of the term and the amount of your payment applied to the principal is smallest at the beginning of the term. As you continue making monthly payments, at some point (usually in the second half of the finance term), the vehicle's value will exceed the loan payoff amount, creating equity, which is the positive trade-in value of the vehicle.
Early termination charge methods. The amount of each monthly payment allocated to depreciation depends on the formula used by the lessor. Two formulas are (1) the Constant Yield (Actuarial) method, the most commonly used method More�info Example, and (2) the Rule of 78 method. More info Example The federal Consumer Leasing Act requires the lessor to disclose the amount or the method used to determine the amount.	Payoff methods. There are different formulas for calculating finance payoff amounts. The payoff amount will depend on the method the lender uses to compute interest on the loan. These methods include (1) the Simple Interest method More�info Example (2) the Rule of 78 method More�info Example (3) the Constant Yield (Actuarial) method More info Example and (4) the Daily Simple Interest method. More�info Example The federal Truth in Lending Act does not require the lender to disclose the method it uses. However, you may ask the lender which method is used. Although you are contractually required to pay a certain amount of interest, the lender is usually required by law or contract to rebate to you some or all of the unearned portion of the interest when you prepay the loan. As a result, when you prepay, the total amount you must pay will equal the principal plus the earned interest and other charges.
Options at early termination. You typically have three options at voluntary early termination: Return the vehicle to the lessor and pay any early termination charges due. Trade in the vehicle to a third party (such as a dealer or leasing company). If the proceeds exceed your lease balance, you can apply the excess to your lease or to the purchase of another vehicle, or receive the excess in cash. If there is a shortfall, you are responsible for the deficiency. You may pay the deficiency, or you may be able to include it as part of the amount financed (if you finance the purchase of another vehicle) or the gross capitalized cost (if you lease another vehicle). Exercise any early termination purchase option, re-sell the vehicle, and use the proceeds to offset the amount you paid for the vehicle.	Options at loan payoff. Generally, you have three options if you decide to prepay your loan: Pay off the loan and keep the vehicle. Trade in the vehicle to a third party (such as a dealership). If the trade-in value of the vehicle is higher than the loan payoff amount, the third party will refund this difference to you or apply it toward your new vehicle purchase or lease. If the trade-in value is less than the loan payoff amount, you are responsible for the deficiency. You can pay the deficiency or ask the third party to add it to the amount financed (if you finance the purchase of another vehicle) or the gross capitalized cost (if you lease another vehicle). Sell the vehicle (if permitted by your contract) and use the proceeds to pay off your loan.

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Last update: May 5, 2003