At first blush, car leasing seems like a grand idea. After all, you can get more car for the same monthly financing payment. Who wouldn’t want that? Well, there’s a lot more to weigh between financing and leasing than simply getting more car for your buck. Although, that is the primary reason people lease.
Numbered among the other reasons people lease is the thrill of that new car smell. Some folks simply like the idea of driving a new car every two or three years. Leasing also streamlines writing off your vehicle as a business expense at tax time.
Another reason to lease is that sometimes the carmakers offer really sweet leasing deals that aren’t available to those financing a car purchase. Repeat leasers also always have a car that’s usually under a factory warranty. And finally, when the lease expires, you don’t have to negotiate a trade-in value or go through the selling process. You just hand over the keys and walk away. Easy peasy, right? Well, usually. Read on.
What is a Car Lease?
A car lease is basically a long-term rental for a contracted number of months. Unlike financing a car purchase based on you eventually owning the car, leasing is like a long-term rental. You are still locked into the deal for a contracted number of months and a monthly payment.
However, instead of paying down a loan and building equity, you are paying for the car’s estimated lost value (depreciation) during the term (length) of the lease. You are paying for that and the interest on the money borrowed to underwrite the lease.
What Do You Need to Know Before Leasing?
Arguably the key concern when considering car leasing is, on average, how many miles you drive yearly. According to the United States Department of Transportation, most Americans drive a total of 13,476 miles per year.
Signing a lease binds you contractually not to exceed an established mileage limit. That limit, or mileage cap, is averaged out over the number of years in the agreement.
Depending on the lease, agreements range from 10,000 miles per year to as many as 15,000 miles per year. Whatever the limit might be, the leasing company will penalize you for every mile above the limit. Generally, that penalty can be between $0.12 to $0.30 per excess mile. At $0.30, that works out to $300 for every 1,000 miles over the limit. It can add up.
Can I Negotiate the Price of a Leased Car?
Yes. As with a financing deal, you can save yourself money by negotiating down the car’s selling price you are going to lease.
What is the Money Factor in Leasing?
When you finance a car, you must also pay for the money you are borrowing. What you pay is called interest, and it’s displayed as a percentage (2.5%, 3.0%, and so forth). You need to know the rate of interest you will be paying. The higher the interest rate, the higher your monthly payment.
When you lease, you must also pay for the money the lessor used to buy the car. In leasing, however, the interest is called the money factor. It’s calculated and displayed differently (0.0010, 0.0023, and so forth). How in the world do you know what the interest rate is on a lease, right?
To translate the money factor into a form more easily understood, just multiply it by 2,400. So, 0.0023 x 2,400 = 5.5%. We know: Why don’t they just say that?
Who is Responsible for Maintaining a Leased Car?
The leasing company expects you to maintain your leased car carefully. That means following the maintenance schedule outlined in the owner’s manual. The good news is, many new vehicles come with some sort of free maintenance plan.
At the end of the leasing period, an agent of the leasing company will inspect the vehicle for any damage beyond “normal” wear and tear. Determining what is normal is entirely up to the inspector. If the inspector decides any damage is beyond normal wear and tear, you will be charged for it.
Who is Responsible for Insuring a Leased Car?
You are responsible for insuring your leased car. The leasing company dictates the amount of coverage you must have for the vehicle. Determine what those amounts will be and contact your automobile insurance agent to establish the annual premium before you lease.
What if I Want Out of My Lease Early?
It bears repeating: A car lease is a binding contract. The leasing company sets the monthly payments based on the length of the lease established in the agreement. If for some reason — any reason — you want or need to bail on the lease early, there will be a penalty for doing so.
At worst, that penalty may require a balloon payment to cover the remaining outstanding payments. You can’t just return the leased car or sell it to pay off the leasing company. It’s not your car, and you have no equity in it.
Market conditions these days make it possible to negotiate with a dealership if you’re planning to buy a car. Or, because the used car supply is tight, dealerships may be more willing to make a deal to get you out of your lease early.
Brokers with auto lease transfer companies like swapalease.com can also attempt to connect you with a deal that lets you sign over the lease to someone else.
Before you make any choices, weigh all your options to determine the best option for you.
How Does My Credit Affect Car Leasing?
As with financing a car purchase, a leasing company will use your credit score and history to determine whether or not it will lease to you. Roughly 83% of new car leasing during the first three months of 2021 was to borrowers with a credit score above 660. This is according to the national credit bureau Experian. It also found that the average credit score for leasing during that period was 734.
If your credit score is 501 to 660, you may be able to find a lender willing to lease to you, but expect to put down a hefty down payment. Also, you can expect to be tagged with a higher-than-average interest rate.
It has always been true that leasing generally requires better credit than financing. When leasing, you have little or no skin in the game. All you stand to lose if you stop making your lease payments is whatever down payment you made.
You don’t now and never will have any equity in a leased vehicle. You are really renting it, remember? Leasing companies know you have little to lose. Consequently, they tend to be pickier when evaluating lessees rather than buyers.
RELATED STORY: Can I Buy a Car with Poor Credit History?
Car Leasing vs. Buying
Whether you lease or buy and finance your next car, you will be obligated to make a monthly payment. In most cases, both will also require some amount of money upfront. When financing, it’s usually a down payment of some sort.
With leasing, you may have to put up a security deposit, the first month’s lease payment, a fee for arranging the lease (acquisition fee), a down payment, or some combination of those. In either case, there are also car title and registration fees.
Pros of Leasing
Because you are only paying for the estimated depreciation while driving the car and not the entire purchase price, monthly leasing payments tend to be lower than financing payments. It simply means your money will go farther leasing a car than financing one. A lower monthly payment is the top reason people give for leasing. It isn’t the best reason, but it is the most common.
Another perk of leasing is the freedom to drive a new car every two or three years with no strings attached. A side benefit of having a new car every few years is, you probably will always have a vehicle protected by the factory new car warranty. There may even be a free maintenance warranty for a portion, if not all, of the lease. And, every couple of years, you can have a car with the most up-to-date technological advances.
At lease end, you don’t need to worry about the hassle of selling the car or negotiating its value as a trade-in. You drop the keys on the lessor’s desk and walk away.
Leasing is better geared to writing off the cost of driving on your taxes if you can deduct business expenses.
Here’s some excellent news: If you still like the car at the end of the lease, you can buy it. Because the leasing company estimated what the car would be worth at the end of the lease (the residual value or residual), they may have guessed wrong.
If they underestimated the car’s worth at the end of the lease, you could cash in by buying that car for less than the current market value. It’s the smart thing to do in a tight market when supply struggles to meet demand.
RELATED STORY: How to Profit from an Off-lease Car
Cons of Leasing
Yes, the idea of driving a new car every few years with the benefit of always being under warranty is tempting, as is that lower monthly payment. Sadly, though, it means you will never build any equity. What you pay for with a lease is the depreciation. A car will lose roughly 35% to 40% of its value in the first three years. At the end of the lease, you won’t have a thing to show for those two or three years of payments.
Typically consumers sign a closed-end lease. There are also open-end leases. The difference is discussed in What Are the Types of Leases? in the section below. Closed-end is the type of lease covered here.
Driving a leased car is like counting calories to lose weight — every mile driven counts. Every lease comes with a mileage limit. It may average out as low as 10,000 miles per year, although 12,000 miles is more likely. You may be able to find a lease with a yearly cap of 15,000 miles. There are even some more expensive high-mileage leases on the market.
You’ll pay more per month but may avoid getting slapped with a mileage penalty at the end of the lease. That penalty is usually about $0.25 per excess mile. If you do a lot of driving, that can really add up.
The leasing company will hold you accountable for anything beyond its definition of normal wear and tear. You will be on the hook for any repairs the lessor deems over and above normal. Suddenly, with the excess mileage fee and damage fee, returning that leased car isn’t the easy-peasy experience expected.
Leasing is also like joining a street gang. Once you’re in, you’re in. Suppose some change in your life creates the need to get out of the lease early? Good luck. You may find yourself faced with owing a balloon payment equal to the outstanding payments on the lease. At the very least, you will have to pay some sort of stiff penalty. There are online companies like swapalease.com, brokering deals between people who want out of a lease and people willing to pick up a lease. But, such brokered deals will cost you, too.
Pros of Buying
The top advantage to buying versus leasing is that the vehicle is yours when the loan is paid off in five or six years. There will be the value you can cash in by selling or trading it in as a down payment on another car. It’s an asset. Of course, you can always decide to drive it until the wheels fall off. No payments for another five years or more is a pretty good perk. Especially when you consider by year four, the repeat lessee is paying for the depreciation on a second new car and still gaining zero equity.
Getting out from under your car loan is much easier than breaking a lease. As long as the lienholder is paid off, you can sell or trade in your car at any time.
Cons of Buying
Particularly if your credit is a bit sketchy, you may want to put down a larger down payment of around 20% if you want better odds of getting approved. That would be $5,000 on a $25,000 car. Leasing would allow you to keep at least some of that up-front cash.
Depending on the length of the loan, depreciation, and the way interest is calculated, you may owe more than the vehicle is worth until the last year or so of the loan. By that time, the car warranty may well have expired, too. Not only do you have to continue making payments on a 5- or 6-year-old car, but you may have to pay for any repairs out of your own pocket.
The Differences of Leasing a Car vs. Buying a Car
You can draw some fairly strong contrasts between leasing and financing. Both have advantages and disadvantages. Short term, a lease will cost less. In the long run, however, two leases will cost more than buying one car. And, at the end of five or six years, the loan will be paid off, and whatever value the car retains will be yours.
Here are some other stark differences.
- Monthly payments: Leasing payments are almost always lower than financing payments on the same vehicle.
- Early Termination: You will pay a hefty fee if you want to end a lease early.
- End of term: Although you may owe some penalties, you can just hand the car back to the lessor at the end of the lease.
- Mileage: A lease restricts the annual mileage. Exceeding that mileage will cost you big.
- After-market: A leased vehicle is not yours to do with as you wish. Any alteration will cost you.
- Taxes: Leasing a vehicle allows you to write off the monthly payments as a business expense if you’re eligible.
- Warranty: Most leased vehicles come with a warranty that will likely cover your car for the duration of the leasing period, saving you money should something happen to it.
- Monthly payments: For the same vehicle, financing payments will almost always be more than leasing.
- Early Termination: You can sell or trade in a financed vehicle at any time, as long as you satisfy the loan balance.
- End of term: When the loan is paid off, the car is yours to keep, sell, or trade in.
- Mileage: There are no mileage limits with a financed car.
- After-market: Financing a car allows you to make it yours. Take care not to void the warranty. Otherwise, customize it to your heart’s content.
- Credit: If you have bad credit, you will most likely have to put down a bigger down payment to get approved.
Leases aren’t one size fits all. The leasing concept doesn’t vary, but the contract details do.
What is a Closed-End Lease?
A closed-end lease is the most common form of leasing. Sometimes called a “walk-away” lease, it sets firm terms, allowing the lessee to walk away at the end of the lease. All variables like the length of the lease, monthly payments, and the mileage cap are established in the leasing contract. As long as the contract terms get met, the lessee can just drop off the car at the end of the lease. The lessee also has an option to buy the vehicle at a pre-determined value.
What is an Open-End Lease?
An open-end lease is a bigger gamble for the lessee, who is accepting more of the risk. Typically that lessee is a commercial enterprise or business. The leasing company still sets a residual value and the monthly payments. Luckily, open-ended leases usually have more flexible mileage options than their closed-ended lease counterparts. However, unlike a closed-end lease, it’s the lessee taking the hit if the residual value at the end of the lease is less than the vehicle’s actual market value. The lessee must pay the difference.
What is a Single-Pay Lease?
Also called a one-pay lease, this is a lease in which you pay the entire run of monthly payments upfront. There are two primary reasons for going this route. One, it usually reduces the interest or money factor rate. You wind up paying hundreds less than if you were to pay monthly. Two, if your credit is questionable, a single, up-front payment may motivate a leasing company to take a chance on you.
How Long is a Car Lease?
You may find carmakers offering leasing specials of odd durations, 39 months, for instance. But, generally, leases are for 24 or 36 months. You can, however, find leases out there for longer terms. As with financing, the longer the term of the lease, the lower the monthly payment. That difference, though, may not be much.
What is a Leasing Mileage Cap?
Even when you finance a car, the higher the mileage when you sell it or trade it in, the less it’s worth. The difference with leasing, the lessor factors in a specific number of miles when estimating depreciation. Over the course of a lease, the allowable mileage or mileage cap might average out to 10,000, 12,000, or 15,000 miles per year. Exceeding the mileage cap reduces the car’s value at the end of the lease. This is why a leasing company will charge you a predetermined penalty for each mile over the cap. Be sure you know the per-mile penalty before signing the lease.
Can a Car Lease Be Extended?
Say you haven’t found a replacement vehicle, and you are at the end of your lease. Is there a way out? Yes, most lessors will gladly extend the lease on a month-to-month basis or for a fixed number of months. You will have to continue making the monthly payment. Also, in the case of a multi-month extension, you may have to sign another contract.
What Are the Key Leasing Terms I Need to Know?
We have been using some reader-friendly shorthand in this guide, but here are the formal leasing terms you should understand.
- Acquisition Fee: This is a fee a lessor charges for setting up the lease. This fee varies greatly and can be as much as $1,000. Ask before signing any lease what fees get included in the acquisition fee. Fees you might see could include destination charges and documentation fees for processing the lease title, license plates, and car registration. It is firm and can’t be negotiated away. However, it can be folded into monthly payments.
- Allowable Mileage: Also called the “mileage cap,” it is the average number of miles per year you can drive the car. The lessor will penalize you for every mile above that number.
- Capitalized Cost: This is the agreed-on selling price of the vehicle plus any fees to be included in the monthly payments.
- Capitalized Cost Reduction: Also called cap reduction, it is any element lowering the capitalized cost. It usually takes the form of a down payment or trade-in allowance.
- Depreciation: The lost value of the vehicle over the course of the lease is the depreciation.
- Disposition Charge: This is a charge to clean and dispose of your car at the end of the lease. You may be able to negotiate it away if you buy the car or lease another from the same agency.
- Drive-Off Fees: Any fees and deposits due to begin the lease. Don’t forget that sales tax will be due for your lease transaction. Ask the lessor what fees are included in the drive-off fees. You may be able to negotiate some of the lessor’s tacked-on fees.
- Early Termination: Breaking a lease contract before the end of the leasing period. If you want out of your lease early, it will cost you dearly. You may need to come up with a sum of money equal to the remaining payments.
- Gap Insurance: Some leases automatically include gap insurance in the capitalized cost. If the car is a total loss through theft or collision, your insurance may not cover the entire loss. Gap insurance pays for what your car insurance doesn’t pay.
- Lessee: The party leasing the car.
- Lessor: The entity financing the lease. It could be a bank, credit union, or a carmaker’s financial division.
- Money Factor: In financing, this is called the interest rate, but it looks markedly different. As with financing, though, the higher the money factor, the larger the monthly payment.
- Payoff Amount: This is what it will cost you to buy the car at the end of the lease. It should be roughly the residual amount minus any security deposit.
- Term: The length of the lease.
Is it Possible to Lease a Car for One Year?
It is possible to lease a car for one year. But, why would you? A car depreciates as much as 30% by the end of the first year. Because your monthly payment is based on depreciation, that one year will be wildly expensive. You might do better with a long-term rental car. It’s worth checking out. Another idea you could try is a club. These are offered by luxury car club leasing companies and sometimes by manufacturers. The clubs allow members to drive new models for short periods of time. They usually include insurance and don’t require a long-term contract.
Can I Lease a Used Car?
Yes, you can lease a used car. In fact, most dealerships offer leasing incentives on their certified pre-owned (CPO) vehicles. These are gently used, newer model cars with factory warranties and other CPO benefits.
How to Lease Your Car
For the most part, the process of shopping for a leased car is about the same as shopping for a vehicle you plan to buy. Research is the key. Other steps to take include:
- Check your credit score. A credit score under 600 will be a very tough sell. When your credit score is low, the down payment is typically larger to get approved. The higher your credit score, the lower the money factor.
- Crunch the numbers. Figure out how much cash you can pay upfront. Some deposits and fees must be paid when you sign a lease, and many are not negotiable. The lessor may also demand a down payment.
- Determine the average annual mileage you drive. Your lease will have an average annual mileage cap of 10,000 to 15,000 miles. Be realistic about your driving habits. You will pay a penalty for every mile over the cap.
What to Look For in a Vehicle to Lease?
Find a model that retains its value. Some brands of vehicles simply retain more value as they grow older. Brands like Subaru, Lexus, Jeep, and Ram tend to retain much of their value through the years. When you buy a vehicle, value retention is important, but not until you sell it or trade it in. Value retention in a leased vehicle is important because the more value a leased vehicle is expected to retain, the lower the monthly payment.
What Questions to Ask Before Signing a Car Lease?
Here’s a list of questions to consider asking the dealership or other lessor before you leap.
- What is the residual value for the car I’m leasing?
- Once the lease ends, what is the price I can buy the car for?
- What is the money factor? If you don’t want to do the math, ask for it in percentage form.
- What is the monthly payment grace period?
- What is the delinquent fee for late payment?
- Will I be charged any other fees at the end of the lease?
- What are the penalties for early lease termination?
- What is normal wear and tear?
- How much do you charge per extra mile driven?
How Can I Reduce a Monthly Lease Payment?
- Reduce the capital cost by negotiating a lower vehicle purchase price.
- Ask for a lower money factor. Particularly if your credit score is over 750, go for a lower rate.
- Put additional money down or, if there’s a trade-in, negotiate for a higher trade-in value.
- Shop other dealers for a better deal.
What Are the Negotiating Points in a Lease?
- The vehicle purchase price is framed as the capital cost.
- The down payment.
- The trade-in value.
- The money factor.
- The disposition fee.
What Can’t You Negotiate in a Lease?
- Residual value is generally set in stone. You can give it a try, but don’t expect much.
- Acquisition fee. This is a charge that lessors rarely budge on.
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