Why Do Car Leasing Deals Differ So Much?

July 7, 2010
If you’re knowledgeable about car leasing, or what they tend to call here in the UK contract hire, then you’ll have noticed a plethora of online brokers offering all sorts of deals. If you have searched online (and 85 percent of people do before they acquire a car) then you’ll have received a pile of different quotes with different terms and very different prices.

But why do the prices you’re quoted differ so much? What’s actually going on here? 

Leasing a car is fundamentally different from buying it because the risk of the car’s value in  36 or 48 months time is held by the financing company and not you, the purchaser. A new car is sold by the manufacturer by some combination of the cost to manufacture with profit added on subsequently, and there’s a generous dose of competitive pressure and a bit of what the manufacturer thinks the market can bear. That figure may differ a bit, with different dealers taking different commissions and perhaps different nominal discounts on the sticker price, but the differences will not be extreme. 

However for a financing company working out a car leasing arrangement, then they need to estimate how much that car is going to depreciate over the life of a contract and cover that loss each of the 36 or 48 months. They then need to take into account the time value of money as $1 in three years is not worth $1 today. The ‘net present value’ is less partly because of inflation and partly because there’s always a risk-free alternative investment such as gilts or Treasury bonds which will pay a guaranteed nominal return over the same period. That return is achieved no matter what and is the base case against which all other returns have to be judged. Of course, the risk-free return in this case has to be calculated against the total capital amount invested in the vehicle because the financing company has had to purchase the entire new car from the dealer or manufacturer.

So, in order to allow someone to lease a car, the financing company has to consider at least the following factors:

  • The new price of the car to be paid  
  • The probability-adjusted range of values for the car at the end of the contract  
  • The cost of capital for the financing company itself  
  •  The probability of significant damage / non-return of the car  
  • The probability of non-receipt of monthly payments (i.e. acquirer default)  
  • The total cost of administration  

The second is the most important and varies tremendously between companies. Two otherwise totally sensible market participants can have very different views on what any one car brand and range will be worth three years old. Therefore all the financing companies compete with very different prices across different models. 

The brokers that you deal with are likely to be independent brokers as independent brokers tend to outperform in-house teams by working harder and keeping in touch with potential purchasers like you just that little bit better. But at the same time brokers are highly incentived to push some of their financing companies more than others because they are heavily incentivised by volume agreements. They would much prefer to broker ten cars from one company than twelve from twelve different companies. So you won’t get a complete picture of the market from any one broker, because they will be pushing one financing company harder than alternatives. 

As we discussed, there’ll be a wide range of prices across the market for the same car depending on the different underlying assumptions and you’ll unfortunately need to try more than 6-7 brokers to make sure you’ve covered the market.

At the same time, returns and dealers wanting to hit their own individual volume targets mean that car sales prices are sometimes lower.

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