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What Is a Car Lease and How Does It Work?

Leasing a car is similar to a long-term rental. You'll generally have to make an upfront payment, plus monthly payments, and get to use a car for several years. At the end of the lease, you'll return the vehicle and have to decide if you want to start a new lease, purchase a car or go carless. Read on for more on how a car lease works and whether it may be the right choice for you.

What Is a Car Lease?

A car lease is an agreement between a lessor (the company that owns or will buy the car) and the lessee (the person who will pay to borrow the car).

When you lease a vehicle, your monthly payment will be calculated based on the vehicle's depreciation—the change between its current value and its value at the end of the lease—plus interest and fees.

Your lease agreement covers the following:

  • How much you have to pay at the start of your lease.
  • The lease's length—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.
  • The "money factor" or rent charge, which is similar to an interest rate on an auto loan.
  • Possible termination fees if you want to return the car before the lease ends.
  • How many miles you're allowed to drive each year. Many leases only allow you to drive 10,000 to 15,000 miles annually; you may be required to pay a per-mile fee if you go over the limit.
  • How the lessor 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.
  • What happens if you miss a lease payment.

Some of the rules may seem restrictive, but remember, you don't own the vehicle. The lessor 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 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 always drive the latest-model cars, leasing could be less expensive than buying and selling a vehicle every couple of 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.

What Are the Disadvantages of Car Leasing?

Leasing a car isn't for everyone, nor is it always a great idea:

  • In the long run, leasing will cost more than buying and holding on to a vehicle.
  • You're paying for the depreciation at the beginning the car's life, when it depreciates the most.
  • There are many potential fees and penalties.
  • If you don't need a car anymore, getting out of a lease can be expensive. And you might not be allowed to take the car with you if you move to a different state.
  • You can't customize the look or features of your car during the lease unless you pay hefty penalties at the end.
  • You won't have a car once your lease ends.

What Credit Score Do You Need to Lease a Car?

As with taking out an auto loan, leasing may be easier and less expensive if you have good credit. The cars you're allowed to lease may be limited if you have bad credit.

Generally, car leasing companies prefer customers who have a FICO® Score* of at least 700. Higher scores might also help you qualify for a lower monthly payment. This is because your credit can impact your money factor, the financing charge portion of your monthly payment.

Some dealers offer leases on used vehicles, which may be easier to qualify for if you have bad credit. However, the lease may have high fees and lack many of the advantages that come with leasing a new car. For example, you may be responsible for all the repairs and maintenance during the lease.

You might be better off trying to improve your credit and finances and then looking for a lease. Or consider purchasing a used car that's a better match for your budget.

What to Consider Before Leasing a Car

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 if you offer to buy the car, buy a car or start a new lease with the dealership.
  • 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 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) with 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 lessors against one another to get the best deal.
  7. Sign a lease with the lessor that offers you the best deal. Be sure to read the entire agreement to make sure it reflects what was promised during the negotiations.

Preparing to lease a car involves evaluating your finances and researching cars and lease terms. Doing so will not only help you get the best deal, but could help you get into the car of your dreams.


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