How Does Leasing a Car Work?
Leasing a car can give you the chance to drive a new vehicle for a monthly payment that’s usually less than the price of a car loan payment. As new car prices have been rising, leases have become more popular, hitting a peak in 2016 when about 30% of all new vehicles sold were leases, according to Cox Automotive.
Consumers are gravitating toward leasing because they like the idea of driving a new vehicle packed with the latest tech, safety and design features without making a significant commitment. But there are downsides, like the fees you might have to pay for exceeding mileage limits or getting out of the lease early. Plus, when the lease ends, the car belongs to someone else, not you.
So, how does leasing a car work exactly? We’ll explain the differences between leasing and buying and what to expect from a car lease if you decide it’s the right move for you.
What is the difference between leasing and buying a car?
When you buy a car, you own it free and clear once your loan is paid off. Leasing, however, involves making monthly payments to drive a car for a few years. Once your lease term is over, you do not own the vehicle. Instead, you typically have the option to buy it, return it, or return it and lease or buy another vehicle.
It is important to note that leasing is different from renting. Leasing is a longer commitment, usually two or three years, in which time you use the car as a regular vehicle for personal use. While you lease a vehicle through a car dealership, you rent one via a rental agency. Renting may come in handy if you’re traveling for work or pleasure and need a vehicle to get you around for a short period of time.
Pros and cons of leasing
As with buying, leasing comes with a number of advantages and drawbacks. Let’s take a closer look at what they are.
- Access to the latest features: When leasing a new car, you can enjoy access to the newest safety and tech features. Though less common, it’s also possible to lease a used car.
- Lower monthly payments: Lease payments are almost always lower than car loan payments. A lease can give you the chance to drive a car that you may not be able to afford to buy.
- Little to no maintenance cost: Since most leases come with full warranty coverage, you won’t have to worry about spending a great deal of money on maintaining a vehicle if you choose to lease.
- Greater freedom: If you are planning a major lifestyle change — like moving abroad — a two- or three-year lease can give you more freedom. You won’t have to go through the hassle of selling or shipping your car when it comes time for you to move.
- Tax advantages for business owners: If you own a business, you can deduct the standard mileage rate for the business miles driven or claim actual expenses, including lease payments, without incurring any penalties that come from selling a purchased car for a gain.
- More costly in the long-run: Since you pay for the depreciation of the car without gaining any equity, leasees wind up paying more for their vehicles over time than buyers.
- Early termination penalties: If you end your lease early, you can expect to be hit with expensive fees. You may be able to trade in a leased car, but don’t count on it. There may be other tricks to get out of a lease early.
- Mileage limits: Most leases limit the number of miles you may drive per year. Typically, you can only drive 12,000 to 15,000 miles per year and will be required to pay fees if you go over the allotted mileage. These fees may be as high as 25 cents per mile but are typically closer to 20 cents. You may also have to pay an acquisition fee at the beginning of the lease and a disposition fee at lease end, each of which could be hundreds.
- Damage fees: If you exceed what is considered normal wear and tear, you may have to pay extra charges when your lease term is up. In most cases, dents on the exterior, scraped bumpers, a cracked windshield, excessive tire wear and tears and stains on the upholstery warrant damage fees.
What to know before leasing
Before leasing, there are certain factors you should consider. Be sure to pay attention to the following before committing to a lease.
- Your budget: Look at your budget and determine whether you can afford the monthly payments and upfront costs of a lease. Upfront lease costs could include your first month lease payment, a refundable security deposit, the acquisition fee we mentioned earlier, taxes, registration and other fees plus a down payment, which we’ll talk about next.
- A down payment: While many lease agreements don’t require a down payment, you may want to put some money down to lower your monthly payments.
- The length and annual mileage: Make sure you are clear on how long your lease term will be and how many miles you’ll be able to drive each year without getting hit with a penalty. If your lease is for 10,000 miles per year but recent life changes now have you anticipating lengthier travel, you may want to change your lease agreement to include a higher annual limit. The higher the mileage limit, the higher the cost of the lease.
- GAP insurance: GAP insurance (“Guaranteed Asset Protection” or “Guaranteed Auto Protection”) insurance covers the difference or “gap” between how much you owe on your car and its actual cash value in the event it is totaled in a car accident. If you check your leasing contract, you may find that GAP insurance is rolled into your lease payments as this is a common practice. You may benefit from GAP insurance if you didn’t put much money down and still owe a significant amount on your lease because you’ll likely owe more than your car is worth if you get into a crash.
6 tips for leasing a car
Here are six tips that are sure to help you land the right lease agreement for you.
- Do your research: Dealerships and manufacturer websites often offer lease specials to those with good or better credit — BMW is one example of a manufacturer with lease specials that are designed for borrowers with excellent credit. If you have a strong credit history, these lease specials may help you land a great deal. But even if you aren’t seeking a lease special, buyers with good credit will receive more favorable rates and terms. Read more about leasing a car with bad credit.
- Look beyond MSRP: The manufacturer’s suggested retail price or MSRP is the price the manufacturer recommends dealerships ask for a car. Since dealers are allowed to ask for more or less than this figure, it is well worth your time to try to negotiate the MSRP down to get to a lower capitalized cost, which we’ll discuss in a minute.
- Comparison shop: Take the time to get lease quotes from at least three different car dealerships. Be sure you are comparing the same terms as you shop around.
- Consider the overall price: The overall price of a lease includes the total of the monthly payments and upfront expenses. Determine the overall price of the lease to make sure you can comfortably afford it and won’t be hit with any surprises.
- Go for a test drive: Even though you’ll only have a lease for a few years, it’s a good idea to test drive the vehicle to make sure you like the way it drives and are pleased with all the features it includes.
- Ask questions: There are a number of questions that you should ask to make sure you’re getting a good deal on your lease that fits in well with your budget and lifestyle needs. These include:
- What is the car’s residual value or value at the end of the lease?
- What is the car’s capitalized cost, or the amount that is being financed with the lease?
- What is the car’s money factor or interest rate you’ll pay during the lease?
- How many miles does the lease include?
- How much money is due up front?
- What fees does the lease have?
- Do you have the option to buy the car at lease end?
How to end your lease
Your leasing company will likely reach out to you and let you know your lease is almost up and ask you to schedule an appointment for an inspection. Before the inspection, it’s a good idea to remove all personal items from your vehicle, wash it and take care of any serious damage so you don’t get struck with fees.
During the inspection, the inspector will come to your home or office and thoroughly evaluate the exterior and interior of your vehicle for about 45 minutes. Once the inspection has been completed and your lease has come to an end, you can go to the dealership your leased car came from and return the vehicle. You may also have the opportunity to buy your leased vehicle in a process known as a car lease buyout. If not, your options at this point are: return the vehicle and walk away, or return the vehicle and lease or buy another.
In the event you’d like to end your lease early, be prepared to pay early termination fees. If your car is eligible for a lease transfer, you may be able to find someone else to purchase your lease and save money on early termination fees.
The bottom line
While leasing may be the ideal option for one person, buying may make more sense for someone else. Before making the decision to lease, think about your budget, lifestyle and future plans. Also, check out our handy leasing vs. buying comparison guide.