Drivers who are looking to get into a new or near-new car but aren't crazy about high monthly payments often turn to leases as a way to get the car they want at a lower monthly rate. But are car leases an option if your credit is less than stellar?
If you have bad credit, leasing a car may be difficult, but it may be easier than buying a car with an auto loan, especially on a new or near-new vehicle. Here's what you need to know about auto leasing, and how a poor credit score can affect the process.
What Credit Score Do I Need to Lease a Car?
Auto leasing companies typically look for FICO® scores of 700 or better, which fall solidly within the ranks of what FICO® regards as "good" credit scores. Before you seek out a car lease, check your credit score and see how lenders and leasing companies are likely to interpret it.
FICO® Scores of 800 or better are typically considered excellent; those from 740 to 799 are seen as very good; scores from 670 to 739 are regarded as good; those from 580 to 669 are fair, and those 579 and below are seen as poor.
If your score is in the fair or poor range, you may have a tough time securing an auto lease. A better understanding of the leasing process and the way credit scores influence it will help you gauge your chances.
Auto Leasing Costs and how Poor Credit Can Affect Them
When you lease a car, you're essentially agreeing to rent it for a fixed number of months (36 is typical), with the understanding that you'll return it to the dealer in "like-new" condition at the end of that period.
Lease payments are based on two factors: 1) The amount of value the car is expected to lose over the duration of the lease (known as amortization or depreciation) and 2) interest charges.
Amortization is the "principal" portion of the lease payment. It's calculated by subtracting the car's residual value—the amount it is expected to be worth when you return it at the end of the leasing period—from its purchase price (or capitalization cost) at the start of the lease. For example, if a car that costs $30,000 today has a projected worth (or 36-month residual) of $21,000 at the end of a three-year lease, amortization would be $9,000. When you lease a car, you're effectively getting a loan on that amortization amount.
Leasing agents characterize the interest you're charged on that amortization in terms of money factor or lease factor—typically a small decimal fraction, such as 0.0028. This figure, which leasing agents may have leeway to negotiate, is an alternate way of expressing the interest rate on the lease. (You can calculate the interest rate by multiplying the money rate by 2,400; a money rate of .0028 equates to a 6.72% interest rate.) The higher the money factor, the greater the amount of interest you'll pay over the life of the lease. Customers with lower credit scores may have to pay higher interest than those with good or excellent scores.
Also, keep in mind that you may not be able to lease your first-choice car depending on your credit. Be open to other models that may be more likely for you to secure.
Additional costs connected with auto leases include:
- Acquisition fee: This is a processing charge, usually less than $1,000, required for originating a lease. Leasing companies typically charge the same fee amount on every lease, regardless of the monthly payment amount (or applicant credit standing), and the amount is typically non-negotiable. You usually have the option of paying this fee upfront or rolling it into your monthly charges to spread the charge out over the span of the lease.
- Security deposit: Auto leasing companies typically require a security deposit roughly equal to one month's lease payment. The sum is refundable at the end of the leasing period, but if you return the car in less than like-new condition, the leasing company can use these funds for repairs or cleanup. As with apartment landlords, car leasing companies may require leaseholders with poor credit scores to pay larger security deposits than they require for customers with excellent credit.
- Capitalization reduction: This is an optional upfront payment, analogous to a down payment, you can make to reduce the base price used to calculate amortization. In our example of a car worth $30,000, today with a projected value of $21,000 in three years, a capitalization-reduction payment of $2,000 would effectively lower the car's starting price to $28,000, reducing the amortization amount from $9,000 to $7,000 and trimming monthly payments accordingly.
- Gap insurance: This is an optional added insurance policy designed to cover you in case you total the leased car in an accident. A gap policy covers any difference between what your auto insurance company pays out on the loss and the residual value of the vehicle. The likelihood most leaseholders will need gap insurance is small, but it can prevent hefty expenses in the event of a bad accident, especially on high-priced vehicles. Some leasing companies embed gap insurance coverage (and associated fees) into their leasing contracts, so if you're considering a gap policy, check to make sure you're not paying for double coverage.
- Disposition fee: Leasing companies charge this fee, which is typically several hundred dollars (but less than $500), at the end of the lease, to prepare the car for resale. It covers washing and detailing the car, document processing, and the like. The fee is waived if you buy your vehicle at the end of the leasing period and may be deducted from your security-deposit refund if you're entitled to one.
Other Options for Getting a Car if You Have Bad Credit
If your car lease application is turned down because of your poor credit score, there are still some alternatives that can put you behind the wheel. Many are pricey, and your credit history could still be an obstacle to using them, but they're worth investigating while you take steps to boost your credit scores.
- Buy-here-pay-here (BHPH) car dealerships: These independent used-car dealers provide auto financing themselves, instead of through banks or financing companies. They typically cater to customers with poor credit histories, including those recovering from bankruptcy. BHPH loans typically charge much higher interest rates than conventional loans, and BHPH dealers are less likely to show leniency than conventional lenders: A missed payment could lead to repossession of the vehicle without a warning or grace period. Unlike conventional lenders, BHPH dealers typically do not report payment information to the national credit bureaus, so making timely payments on a BHPH loan will not benefit your credit score.
- Lease transfers: Leaseholders who want to get out of their leases sometimes offer to let someone take over the lease for them. When you assume a lease in this manner, you take responsibility for monthly payments under the same terms as the original lease. Leasing companies typically require a credit check on the drivers taking over the lease, but requirements may be less stringent than those for an original lease.
- Vehicle subscription services: Growing in popularity, dealer and third-party subscriptions services essentially allow you to pay to borrow a car. These services lets users rent cars for indefinite periods (and eventually own them if they like). Users make a down payment (or "drive-away fee") proportional to the cost of the vehicle, and then pay a monthly fee for use of the car. If you return the car before a month is up, the fee is prorated, so you only pay for what you use. Users must have a driver's license and submit proof of income. Fair does not lend money, but they do check credit scores as part of their qualification process, so this option may be limited if you have extremely low credit scores.
- Car-sharing services let you rent cars on an hourly or per-day basis. They do require credit checks, but are typically less restrictive than traditional car rental agencies or leasing companies, and can be a good option for drivers with poor credit.
How Do I Improve My Credit?
If you've been turned down for an auto lease because of bad credit, keep in mind that you can take action to improve your credit score, which should help you qualify the next time you apply.
The explanatory information included with your credit score tells you the top reasons your score isn't as high as it could be, and that's a good place to focus your efforts on score improvement. Typically the best ways to start improving your credit scores include:
- Avoiding late or missed debt payments
- Paying down high credit card balances
- Refraining from opening new credit accounts unless you really need them
You can find more about these measures, as well as other credit-building tips, here.
Poor credit scores could put the brakes on your plans to lease a car. If that's the case, keep in mind that you have the power to improve your scores. Take the wheel on your credit habits, and, with some drive and determination, you can build up better credit and qualify for the lease you seek.
Editorial Disclaimer: Opinions expressed here are author's alone, not those of any bank, credit card issuer or other company, and have not been reviewed, approved or otherwise endorsed by any of these entities. All information, including rates and fees, are accurate as of the date of publication.