How Does Leasing a Car Work?

Leasing a car is much like a long-term rental. Generally, you’ll have to make a payment upfront, make monthly payments, and you get the use of the car typically for two to four years. When the lease is over, you’ll decide if you want to extend the lease, purchase the car, sign a new lease on a new car, or go without a car. Before entering into a lease agreement, it’s important to understand how leases work and the restrictions they may impose.

What Is a Car Lease?

A car lease is a contract between you and the lender or financial institution from which you are leasing. It may be an attractive option if you’re not interested in owning a car right now or you prefer to drive newer vehicles. When you sign a car lease you are agreeing to certain conditions set by the dealership.

Your lease agreement covers the following:

• How much you must pay at the start of your lease
• Monthly lease payments and how they’re calculated
• The term – typically a lease lasts for two to four years
• How much the car is currently worth and how much it’s expected to be worth at the end of the lease
• The fees you’ll have to pay at the end of the lease
• Rules regarding early termination of the lease
• The number of miles you’re allowed to drive each year. Many leases only allow you to drive 10,000 to 15,000 miles per year and often require you to pay a per-mile fee if you go over the limit.
• How the dealership defines normal wear and tear and how much you’ll have to pay if there’s excessive wear and tear. If you smoke in the car, have kids, transport pets, or park on a busy street, you increase the chances of fee-inducing incidents.
• Maintenance requirements and responsibilities
• What options you have when the lease term ends including extending the lease on the same car, exercising a purchase option to buy the car, or signing a new lease on a different car.
• What happens if you miss a lease payment

Some of the rules may seem restrictive, but remember, you don’t own the vehicle. The dealership keeps the title, and you have to return the car in good condition at the end.

What Are the Benefits of Leasing a Vehicle?

Leasing a car may be more appealing than buying for several reasons:

• Assuming you’re comparing leasing versus financing a purchase of the same car, the lease payments will generally be lower than the monthly loan payments.
• A lease may require a smaller down payment than purchasing a car with a loan.
• You may be able to afford to lease a brand-new car, complete with the latest bells and whistles, even if you couldn’t afford to purchase the same car.
• If you want to drive a new or newer car every few years, leasing could be less expensive than buying and selling a car every few years.
• Your car will generally be covered by a manufacturer’s warranty.
• You don’t need to worry about selling or trading in the vehicle at the end of the lease and you may have the option to purchase the car at the end of the lease term.

What Are the Disadvantages of Car Leasing?

Here are a few reasons that can make leasing a car a less attractive option than buying a car:

• In the long run, leasing will cost more than buying and holding on to a vehicle.
• You will be limited in the number of miles you can drive and penalties for exceeding mileage limits can be steep.
• You’re paying for the depreciation at the beginning of the car’s life when it depreciates the most.
• There are potential fees and penalties like for excessive wear and tear.
• If you don’t need a car anymore, getting out of a lease can be expensive.
• You can’t customize the look or features of your car during the lease.
• At the end of the lease payment period, you don’t own anything.

What to Consider Before Leasing a Car

Just as you can bargain with the dealer when you’re buying a car, the terms of a car lease are often negotiable. The language in a car lease agreement may be new to you and can sometimes be confusing. Here are some of the common terms and their definitions:

• Acquisition fee: Some dealerships or leasing companies charge an upfront fee for arranging the lease. You may be able to negotiate this fee or find a lease without an acquisition fee.
• Buyout price: You may be able to end the lease at any time by buying the car outright. The buyout price may decrease over time as the car depreciates.
• Capitalized cost: Often shortened to cap cost, this is the initial price of the car. You can negotiate the cap cost just as you would when buying a car.
• Cap cost reductions: You may be able to reduce your cap cost in various ways, such as negotiating the price, trading in a car, or making a down payment. Because you pay for the depreciation between the cap cost and the residual value (the value of the car at the end of the lease), cap cost reductions can lead to lower monthly payments.
• Disposition fee: You may have to pay a disposition fee at the end of your lease to help cover the dealership’s costs for getting the car ready to sell. Even if you can’t negotiate the fee upfront, you may be able to negotiate it down when you return the car.
• Gap insurance: Insurance that covers the difference between a car’s residual value and what your auto insurance company pays out if the car is totaled. Some lessors require you to purchase this and include the insurance premiums in your monthly payment.
• Lease term: The length of the lease, which is often two to four years.
• Mileage allowance: How many miles you’re allowed to drive each year before the per-mile penalty begins. You can sometimes negotiate a higher mileage allowance but may have to pay more each month as a result.
• Money factor: Also called a lease factor, lease rate, or rent charge, the money factor determines part of your monthly payment. The money factor is often shown as a small decimal fraction, but you can convert it into an interest rate by multiplying the number by 2,400. For example, a cap rate of .0025 equals an interest rate of 6%.
• Purchase option agreement: Your lease may specify how much you can purchase the car for once your lease ends.
• Residual value: The value of the car at the end of the lease, which may be determined by a third party.
• Security deposit: You may have to pay a security deposit, which the lessor holds on to and can use to cover damage or extra-mileage charges when you return the car. If you don’t owe any extra fees, you’ll receive the full security deposit back.

Is Leasing a Car Right for You?

Deciding between buying, leasing, and waiting can be difficult, and you’ll want to consider the pros and cons of each option. If you’re looking for a low down payment and low monthly payments, a lease may be best, especially if you want a new car with the latest technology. Otherwise, a used car could be an option. However, if you’re focused on long-term savings and are fine driving the same car for many years, purchasing a car could be a better option than leasing. If you’re looking to buy but are having trouble affording a new car, a certified pre-owned car offers some of the same advantages (such as a warranty) at a lower cost.

How to Lease a Car

If leasing sounds like the right option for you, here are some steps to take to prepare:

1. Check your credit score to make sure you’re likely to qualify to lease a new car.
2. Determine how much you can afford to put down and how much you can afford to pay each month. Don’t forget to include insurance, registration, gas, and any additional expenses that come with owning a car in your budget.
3. Start test-driving different cars to figure out the make and model you’d like to lease. If you’re open to a few options, that could give you wiggle room during negotiations.
4. If you’re trading in a car, try to find its current market value and make sure you’ll receive enough to pay off your car loan balance. You could consider selling the car on your own and using the funds for a down payment on the lease. Or, negotiate the cap cost and trade-in separately to avoid potential confusion.
5. Consider your driving habits and how you expect to use the car to determine what mileage cap you want.
6. Shop around to see which dealership will offer you the best lease terms—a low down payment, low monthly payments, and few fees. You could try to pit dealerships against one another to get the best deal.
7. Sign a lease with the dealership that offers you the best deal. Be sure to read the entire agreement to make sure it reflects what was promised during the negotiations.

When weighing whether to lease or buy a car you need to consider your personal driving habits and preferences as well as evaluate your finances. Doing so could help you get into the car of your dreams.