Quick Facts About Leasing a Car
- Lower monthly car payments are appealing, but you’ll need to have another form of transportation lined up at the end of a lease.
- Leasing a car may be a good option if you are looking for lower monthly payments and prefer driving a new vehicle every few years.
- Even though you don’t own the leased vehicle, you are responsible for its use, including registration and insurance.
Nearly one in five new vehicles is leased each year, according to figures from Autotrader parent company Cox Automotive. Higher interest rates and economic inflation significantly impact consumer buying and leasing habits. Some drivers may opt for this short-term arrangement in favor of lower monthly payments, but is leasing a car a good idea for you? Knowing the ins and outs of leasing is critical to understanding if it’s a good deal.
Here’s our guide to what car leasing is all about — the good and the bad. We’ll cover how leases work, whether or not leasing fits your lifestyle, and how leasing can figure into your budget. We’ll also look at the downside of leasing and what to avoid if you decide this alternative to a car purchase is for you.
- How Does Car Leasing Work?
- Leasing vs. Buying a Car
- Car Leasing Pros and Cons
- How to Tell if a Car Lease Is a Good Deal
- Other Payment Considerations
- Who’s Responsible for a Leased Car?
- What to Expect at Lease End
- Should You Lease a Car?
How Does Car Leasing Work?
A car lease is a contractual agreement between the consumer and the dealership that gives you the right to use the vehicle over a set period. Instead of outright ownership, car leasing works more like a long-term rental. The term length is typically two or three years, but shorter and longer leases may be available. Lease contracts have mileage limits, which means you can drive up to a specified number of annual miles at no additional cost. As the “lessee,” you are charged for exceeding that mileage cap.
The monthly payment is determined by several factors, the largest of which is the vehicle’s depreciation — the amount of value it has lost while you’ve driven it. The number of miles you put on the vehicle and its condition at the lease end also contribute to depreciation. Monthly lease payments also include the cost of financing the transaction.
Additional fees and potential charges may sound overwhelming. Still, a monthly lease payment is usually lower than a loan installment. With a lease, you pay to use the vehicle for a while and not the entire purchase price. Automakers can incentivize cars with special lease deals without affecting the advertised manufacturer’s suggested retail price (MSRP).
Lower monthly payments are appealing, but buying a car only appears to cost more because of the higher monthlies. In a purchase agreement, you own the vehicle at the end of your loan payments and can recoup some higher costs through the resale or trade-in value. At the end of the lease, your lower monthly payments will have netted you the transportation provided by your car and nothing else — and you’ll be left needing a new option for getting around.
Leasing vs. Buying a Car
Leasing a car can make more sense than an outright purchase under specific circ*mstances. The most significant factor is your average annual vehicle miles. If you put less than 15,000 miles per year on your car, leasing might be a good option. Mileage is a crucial element in determining your car’s resale value. A vehicle driven only 10,000 to 12,000 miles yearly will be worth much more than a car that sees 15,000 to 20,000 miles on its odometer annually. The lessor will calculate your payment on the projected resale value — the higher the value, the lower the cost.
Others may opt for leasing because they like driving a late-model car and have budgeted a fixed amount for transportation expenses. There are potential advantages to this scenario. First, you’ll trade into a new car every two or three years. Plus, you might find that a lower monthly lease payment allows you to drive a more expensive model with more features for the amount you’d pay for a less expensive one.
RELATED ARTICLE:Lease vs. Finance a Car: 5 Things to Consider
Car Leasing Pros and Cons
There are a few key benefits and drawbacks to leasing.
Pros
- Lower Payments: Prices of new vehicles continue to climb each year as manufacturers add new features and technology. Leasing allows you to keep your car payment in check. Also, as mentioned earlier, leasing is a good way for automakers to package incentives and rebates into attractive monthly payments. These incentives may be more generous than traditional cash buyers’ discounts or low interest rate offers.
- Newer Cars: High prices also present another challenge to traditional vehicle purchases. To lower payments on a new car, buyers take longer-term loans that can extend beyond five, six, or even seven years. That’s a long time between getting into a new vehicle, especially with the quick pace of model changes and the addition of new technology. If you want to drive a new car, leasing is the way to go since most range from two to four years in duration.
- Less Long-Term Hassle: Leasing also offers the advantage of not worrying about what to do with your old car when you’re ready to get a new one. Since you have no stake in that vehicle, trade-in values or selling it to a private party are non-issues. Also, the shorter lease term means your car will likely be covered by the manufacturer’s warranty the entire time you keep the vehicle. Not so with a buyer who may still be paying down their loan long after the warranty has expired.
Cons
- Limited Mileage: If you drive many miles, you may find it more cost-effective to buy and keep the car. Most leases cap mileage anywhere from 10,000 to 15,000 miles per year. Put more miles on the vehicle, and you open the door to excess mileage charges, some of which can range as high as 25 cents per mile. You could face the prospect of paying thousands when it comes time to turn in the vehicle.
- Added Liability: In addition to mileage, the lessee must cover any damage or excess wear and tear on the car. Scratches and dings are considered normal wear and tear but read the fine print to determine what excess wear and tear looks like and for what and how much you are liable.
- Contractual Obligation: Remember that a lease is a contract, and you’re committed to making the payments for the duration. If you decide you want out, you may still be liable for the balance of your payments. Be sure to check the lease to determine your liability carefully.
RELATED ARTICLE:Lease vs. Buy a Car: Which Is Right for You?
How to Tell if a Car Lease Is a Good Deal
Low monthly loan payments look good on paper, but then there’s all the money you’re required to bring to the lease deal. That includes upfront or down payments due at signing to close the deal. For example, a $1,200 advance payment is like adding $50 to your monthly on a 2-year lease. Also, be aware of additional charges like acquisition and disposal fees. The total can quickly add up. You can also make these additional fees a point of negotiation in the final deal.
All these payments, including taxes, licenses, and registration fees, should be divided by the term and added to your monthly payment to determine your actual out-of-pocket costs.
For a good deal on a lease payment, expect to pay 1% of a new vehicle’s price each month. Consider this example. The average MSRP of a new car today is about $49,500, so a reasonable lease payment would be $495 per month. Of course, you can still find leases for less than that on cheaper cars. For comparison, Cox Automotive data shows the estimated monthly payment for a new car in May 2023 was $768.
RELATED ARTICLE:Can You Lease a Car with Bad Credit?
Other Payment Considerations
Three fundamental factors make up a lease: how much it costs to acquire the vehicle, the interest charged to cover the financing, and what the car will be worth at the end of the lease.
The most significant component is what’s known as the capitalized cost. That’s the amount the lessor pays for the vehicle. It can be below invoice if it’s a slow-selling model or closer to MSRP if the car is in high demand. That amount directly impacts what you’ll pay monthly.
Usually, the vehicle gets acquired with borrowed money, and finance charges get based on the lessor’s cost of money. Since large financial institutions or the manufacturer’s credit arm hold the leases, they can access funds at rates far lower than you’d pay if you purchased the car with a conventional loan. This also helps to reduce the monthly payment.
Any additional money in the form of down payments or manufacturer incentives also reduces the capitalized cost of the vehicle. Another critical factor is the residual or resale value of the vehicle assigned to the deal. A high residual lowers the capitalized cost and lowers the payments. A low residual raises that cost and the monthlies. Review all these figures before signing the lease agreement, especially the residual value. See if it aligns with the current resale value of a comparable model.
Who’s Responsible for a Leased Car?
Since a lease works like a long-term rental, you, as the lessee, do not own the car. More often than not, the actual owner is the financial institution backing the lease. It can be a manufacturer’s credit arm or a bank. Even though you don’t hold the title to the vehicle, you are responsible for its use, which includes registration and insurance.
This responsibility is a crucial point. If you get into an accident or the car gets stolen, and the vehicle is a total loss, you’re responsible for replacing it. You must cover the difference if the replacement cost exceeds the car’s value. Experts often recommend extra-cost GAP (guaranteed asset protection) insurance coverage in a lease.
RELATED ARTICLE: What Fees Do You Pay at the Start of a Lease?
What to Expect at Lease End
Traditional leases come in open- and closed-end contracts. The latter is also known as a walk-away lease, where you have no responsibility outside excess mileage or wear and tear costs. In this case, the lessor is responsible for the vehicle’s disposal. The financial institution profits if the car is worth more than market value. If not, it has to eat the cost. Typically, a closed-end lease will cost more than an open-end contract because of this higher risk to the lessor.
Lessees in open-ended leases share the risk. If the vehicle is worth more, you may see some money back. If it’s not, you may be liable for the difference. Beware of so-called “balloon payments,” where lessors set the resale value artificially high to keep monthly payments down. At the end of the contract, the lessee must come up with this payment.
Open-end leases also have a purchase option. You should know this number up front when you sign the deal. This option to buy can pay dividends if used car values are up. This means you can buy the car you’ve been driving at a below-market price.
Should You Buy Your Leased Car
This decision is ultimately a matter of personal preference. Consider your financial situation, specific needs, and overall satisfaction behind the wheel. Consider these pros and cons of buying your off-lease car:
Benefits:
- Familiarity: After leasing a car for a few years, you become more comfortable with its handling and features. Sticking with a vehicle you know can be satisfying and convenient.
- Cost Savings: After the lease term ends, purchasing the car may cost less than you’d pay to buy something else or start a new lease.
- Avoid the Fees: If you drive more miles than allotted in your contract or have excessive wear and tear, buying the vehicle is a way to avoid those dealer fees.
Disadvantages:
- Depreciation: Cars usually depreciate the fastest in the first few years. When you buy the vehicle at the end of your lease, you pay for the residual value. Since you also pay the expected depreciation cost over the life of the contract, this means you may pay more for the car in the long run.
- Repair Costs: When you buy a vehicle, you are solely responsible for routine maintenance and repairs. With many luxury models, these costs can quickly add up once you’re no longer under the umbrella coverage of the lease.
- Limited Upgrade Options: If you like driving a new car every few years, buying the vehicle makes it more difficult – and more expensive – to keep upgrading to the latest makes and models.
Should You Lease a Car?
Leasing is a good option for many people, but it’s not the best choice for everyone. Here are the main factors to consider when deciding to lease a car:
- How many miles will you drive? If you’re taking frequent road trips or anticipate running lots of errands around town, the mileage limits associated with lease contracts make not be a good fit for you.
- Do you care about driving the latest make and model? If so, you may prefer the lower level of commitment associated with a short-term lease.
- Are you prioritizing lower monthly payments? A lease may be the right option if you are looking for a lower car note. Still, evaluating the long-term costs associated with leasing a vehicle is important. This includes fees and penalties.
- Do you want to customize the vehicle? If you want the freedom and flexibility to make modifications and personal upgrades, a lease is not a good idea. Buying something outright means fewer restrictions and guidelines.
Read Related Articles:
- How to Get Out of a Car Lease
- Car Lease Takeover: What You Need to Know
- Used-Car Leasing: What You Need to Know
Editor’s Note: This article has been updated for accuracy since it was initially published.
