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When you lease a car, your credit score plays a role in the type of vehicle you can get as well as how much you'll pay. According to Experian data, the average credit score for a car lease in the second quarter (Q2) of 2020 was 729, putting it right in the middle of the "prime" borrower category—those with credit scores of 661 to 780.
While a prime credit score gives you a big advantage whether you're leasing or financing a vehicle, it's not required. You can lease a car with a lower credit score, but you'll almost certainly need to make some concessions, such as by paying a higher interest rate or making a larger down payment.
Why a Good Credit Score Is Often Needed for a Lease
When a financing company considers a lease application, they look for indicators that you're a reliable borrower. Your credit score is one of the first things they check. The better your credit, the less risk you pose, since a high score reflects timely payments, low credit utilization and other factors that indicate high creditworthiness.
Your credit will not only affect whether you are approved for the lease, but also what interest rate you'll pay. If your credit score qualifies you for a lower interest rate, your monthly payments will be less.
Monthly lease payments on a car are determined by its expected depreciation and your interest rate. To calculate depreciation (also known as amortization), lenders subtract the vehicle's predicted residual value from its purchase price. The residual value is what they expect the car to be worth at the end of your lease term. Your lease principal is the difference between the purchase price and the residual value.
So, if you lease a car with a purchase price of $25,000 for three years and the residual price is $18,000, your lease principal will be $7,000 paid over the course of 36 months. Your interest rate will be added to the principal and, just as with a car loan (or any other type of financing), borrowers with higher credit scores will receive lower interest rates, and vice versa.
Although lease payments are typically lower than auto loan payments—in some cases by $100 or more, according to Experian data—the share of new vehicles that are leased has dropped in 2020. More than 32% of all new vehicles were leased as of Q2 2019, but that fell to 28% in Q2 2020.
Among leases specifically, the share of nonprime borrowers (601-660 credit score) saw a decline of 8% from 2019 to 2020, but leases by prime borrowers grew nearly 8%. Lease payment amounts have also increased slightly across all borrowing groups except subprime borrowers (501-600 credit score).
Can I Lease a Car With a Bad Credit Score?
The short answer is yes, you can lease a car with a bad credit score—though it may be more challenging. A lender may use your credit score to decide which types of vehicles they'll lease to you, so if you have your heart set on a particular car, your credit score could affect whether you'll be approved for it.
A bad credit score may also result in a higher interest rate on the lease, meaning you'll pay more per month and over the lease term. Lenders may also request a higher security deposit from bad credit borrowers to cover their increased risk.
You may be able to lower your monthly payments, even if you don't have great credit, by making a "capitalization reduction" payment. Similar to a down payment, the capitalization reduction amount is subtracted from the purchase price that's used to calculate your lease principal.
For example, if you put down $3,000 on a car with a purchase price of $25,000, then your lease will be calculated with a $22,000 purchase price. That means you'll have a lower principal and less interest will accrue.
In the event you're unable to qualify for a lease, you might consider a lease transfer. Assuming you know someone who wants to get out of their current car lease, they may be able to transfer it to you so you can take over the payments. Their lender will still run your credit, but they may be more lenient than if you were applying for a new lease on your own.
Can I Build Credit With a Car Lease?
Lenders typically report lease payments to the three credit bureaus (Experian, TransUnion and Equifax) the same way they would loan installments, so a lease can help you build credit. If you make all of your lease payments on time, your credit report will reflect that positive credit behavior. Because payment history is the most important factor in your credit score calculation, on-time payments will go a long way to help your credit score.
On the other hand, if you submit a payment more than 30 days late, that will also appear on your credit history and will lower your score. As with any type of financing, it's a good idea to examine your budget and make sure you can afford your lease payments before you sign the agreement.
When Does Leasing a Car Make Sense?
Leasing can be an attractive short-term option for a car if you don't want to commit to a car loan. But when the lease ends, you must return the car, whereas paying off a loan enables you to own the vehicle outright.
Let's look at some of the pros and cons:
- Ability to drive a newer car
- Smaller down payment than with a car loan
- Lower monthly payments
- Less likely to need costly repairs since the car will probably be under warranty
- Short-term commitment (usually 24 to 36 months), after which you can lease or buy a different car
- No equity or ownership in the vehicle
- Mileage limitations (you're typically restricted to a certain number of miles per year)
- Lease fees
- Possible gap insurance requirement in case the car is totaled before the lease is up
Buying and leasing both can make sense under different circumstances. If your priority is driving a new car and you like the option of switching to a new vehicle every few years, a lease may be right for you. The lower monthly payments may also be easier on your budget, although you still have to account for maintenance and repairs that come up during the lease term.
But taking out a car loan to buy a car puts you on the path to full ownership, so once it's paid off, the vehicle is yours to do with as you please. You can drive it for years with no additional payments or sell it for cash. An auto loan also doesn't restrict your annual mileage, so if you commute a long distance or take long road trips, buying could be a better choice.
What to Know Before Leasing a Car
You may be able to get a better lease deal by negotiating. Not all fees are up for discussion, of course, including the residual value and acquisition fee.
However, the following steps may help you save money:
- Research the vehicle you want to lease. Knowing the market value of the car can help you gauge whether an offer is fair.
- Compare prices at different dealerships. Search online for dealerships in your area and see whether any are offering promotional specials, rebates or other deals on particular vehicles. You might even consider looking at dealers in neighboring towns or counties to see if you can save by going a little bit out of the way.
- Be flexible on vehicle type. Some vehicles are significantly more costly to lease than others. For example, Experian found that the average monthly lease payment for a Honda Civic is $291, while a Ford Explorer is $491. Because of the cost variations, it can be useful to consider a range of vehicle types to get the best deal.
- Negotiate fees. If you know what other dealerships are charging to lease similar models as the car you're looking at, try asking the sales associate to match those other rates or at least bring the price into the same ballpark. You can also ask whether they'll increase your annual mileage limit or reduce the buyout rate if you plan to purchase the car when the lease ends.
You may be able to save by negotiating post-lease expenses as well. If you plan to buy the car or want to lease another vehicle through the same dealer, they may be willing to waive your disposition fee, which is used to cover cleaning and repair costs after you return the vehicle so they can put it back on the market.
Still, one of the best ways to lower the cost of leasing a car is to improve your credit score. You can check your credit score and report for free through Experian to see where you might need help. If you're not in a rush to get into a new car, it could be well worth it to take measures to raise your score. One way to give your score an instant lift is with Experian Boost®ø, which lets you add on-time utility, telecom and other payments to your credit file for free.