Yes, it’s more affordable, long-term, to buy a used car than it is to buy one that’s brand new. But sometimes you just want that dream car. One way to get a new car without the higher monthly car payment is to put a “car on lease,” which refers to the practice of leasing a car instead of buying it.
Definition of Car on Lease
A car on lease is a car that you have for an extended period of time, then return when that time period is up. This basically makes it a long-term rental. You’ll make a monthly payment and have restrictions on the mileage and condition it needs to be in when you return it.
By leasing, you have the opportunity to own a new car at a lower payment than you’d have if you purchased it. Typically, your monthly lease payment will be lower than what a car payment for an equivalent vehicle would be. But for most people, buying is a better financial move. It’s important to look closely at the total cost of leasing before going that route.
Read More: The Best Way to Buy a Car: Cash, Loan or Lease?
How Car Leasing Works
Think of a car lease like a long-term car rental. You’ll pay a monthly fee to be able to drive the car. Your lease will have a fixed term and at the end of your lease, you’ll return the vehicle and either trade it in on another rental or settle up on any remaining amount you owe.
To get started on a lease, you’ll pinpoint the car and track down a dealership that offers leasing options. You’ll need to make a down payment, known as an acquisition fee or an upfront fee in leasing terms, and sign a contractual agreement that binds you to making a monthly payment for a fixed period of time. It’s important to read this agreement thoroughly before signing.
Where to Lease a Car
You’ll likely find many local dealerships offer leasing options, but it’s important to shop around. You can often find lease deals, especially during certain parts of the year. Once you’ve narrowed down your preferred make and model, pull up all the local dealerships and lots offering leases. Also check Edmunds’ Lease Deals section to see if there are any deals on leases for your preferred make and model.
But don’t assume the monthly lease cost can’t be negotiated. Experts advise first visiting a dealership and looking at your new vehicle of choice. Don’t mention that you plan to lease. Once you’ve negotiated a price on the new car, then ask for a lease price. The lease price is based on the sales price of the new vehicle, so negotiating it beforehand can save you some money.
Conditions of Leasing a Car
Once you’ve decided on a price, you’ll have some paperwork to sign. This paperwork will outline:
- Your lease term: You can find lease agreements for as short as three or six months, but typically you’ll sign on for at least a year. On average, car leases are 36 months.
- Your monthly payment amount: Monthly lease payments average $467 a month, according to an Experian survey. This will, of course, vary based on your car’s sale price.
- Mileage restrictions: Typically, leases will limit you to 10,000 to 15,000 miles each year, but this can vary. You may also be able to negotiate this or pay more for a high-mileage lease. A high-mileage lease will give you a higher monthly payment, so you’ll need to determine whether it’s worth it to avoid the risk of the per-mileage fee you’ll pay for going over the limit.
- Wear and tear restrictions: When you return the vehicle at the end of your lease, the dealer will do an inspection. Pay close attention to the requirements in the lease. Will you be heavily penalized for scratches and dents? What happens if you smoke in the car or your children spill something?
- Late payment penalties: As with any lease agreement, you’ll be expected to pay your bill on time every month. Your lease should outline the penalties if you miss a payment or you’re a few days late.
- Covered maintenance: Your lease should come with a manufacturer’s warranty. Before signing, determine exactly what will be covered under that warranty and who will be responsible for maintenance and repairs while the vehicle is in your care.
Requirements for Leasing a Car
Before you head to the dealership to shop for a car, you’ll need to make sure you have the minimum credit score necessary to qualify for a lease. Most dealerships will require that you have a credit score of at least 620 to qualify. This can vary from dealership to dealership, but you’ll find if you have a score of at least 680, you’ll qualify for better rates than if your score is lower.
In addition to making sure you’ll pay your payments on time, the dealership will also want to make sure the car is covered if you total it. For that reason, you’ll have to prove you have car insurance before you’ll be allowed to drive off the lot. This could include collision coverage, to take care of any damage resulting from hitting an object or other car, and comprehensive coverage, to handle theft or damage due to natural disasters.
Benefits of Leasing a Car
If you’re weighing leasing a car against buying one, there are some advantages to going with a lease. They include:
- Everything’s handled by the leasing company: You won’t have to shop around for a car loan or pay sky-high interest by getting a loan through the dealership.
- No need to sell your old car: At the end of the lease, you simply turn your car in and either get a new lease or buy a car. No losing money on trade-ins and no struggling to sell your old car.
- Drive the latest cars: The depreciation on brand new cars can make buying one costly. With a lease, you get the latest and greatest new cars, often with a lower monthly payment than you’d have with a purchase.
- Option to buy at the end: If you fall in love with your lease, you have the option to buy the car at the end. The leasing provider will calculate the residual value, which is the value remaining on the car, and use that to set a purchase price.
- Lower repair costs: Not only are you getting a new car for less, but any major repairs should be covered under the factory warranty. Sure, you’ll probably still have to pay to get the oil changed and the tires rotated, but you won’t have to worry about a major defect as you would with a used car.
- Lower sales tax: It’s a minor savings, but a lease will result in lower sales tax since it’s based on the depreciation, not the cost of the vehicle.
Disadvantages of Leasing a Car
Often the biggest disadvantage to leasing a car comes when you’re comparing it to buying a new car. But if you are fine with a used car, leasing is especially cost-prohibitive. Here are some disadvantages to leasing, some of which can become even more profound if you aren’t set on buying a vehicle that’s brand new.
- Mileage limits: Most leases come with a yearly mileage limit of between 10,000 and 15,000 miles. Go over that mileage and when you return the vehicle, you’ll pay a per-mile fee. You can get a high-mileage lease, but that will come with a higher monthly fee.
- Fees: There are numerous leasing fees you’ll face. One of those is the acquisition fee, which is the upfront cost to set up the lease. You’ll also provide a security deposit, documentation and titling fees, sales tax and, in some cases, the first month’s payment. When you turn the car in, there may also be a disposition fee.
- Higher cost: You’ll pay a monthly payment, which depends on the type of car, the MSRP and the interest rate you’re given. This is in addition to any costs you pay to take the lease and turn the car back in. All this means, long-term, you’ll often end up paying more for a lease than you would if you’d purchased new.
- No trade-in: Although your monthly payments may be cheaper than a new car, you’ll have no car to show for it at the end of your term. That means if you want to purchase a car, you’ll have no car to trade in or sell to offset the cost.
- Early termination limitations: When you sign a lease, you lock in for a fixed period of time – usually at least a year. Some leases allow you to terminate early, but this comes with penalties, along with the requirement that you pay the balance due. You may be able to transfer the lease to someone else or purchase the vehicle to avoid those penalties.
Read More: The Best Auto Loan Interest Rates for 2020
How Lease Prices Are Set
The leasing process can seem complicated to the average consumer. However, the industry has a fixed process for lease pricing. A leasing company’s car lease pricing is based on the car’s depreciation plus interest plus tax. Depreciation is based on the price you’ve negotiated minus the price the leasing company assumes the car will be worth when you return it.
If the car you’re leasing has an MSRP of $25,000, but you’ve negotiated it down to $23,000, $23,000 will be the amount your car lease payment is based on. If the leasing company determines the car will only be worth $10,000 when you return it, your depreciation amount will be tallied at $13,000. The leasing company will put it all together like this:
- Depreciation: A leasing company will look at the capitalized cost, which is $23,000 in this case. The residual value of $10,000 will be subtracted from that to arrive at $13,000. This will be divided by the months in the lease to get a monthly depreciation cost.
- Interest: Interest will be added to your depreciation cost so that the leasing company can make some money on the deal. This takes your capitalized cost of $23,000, adds the residual value of $10,000 to that to get to $33,000, then multiplies that by the finance charge and divides it by the lease term to get the monthly interest cost.
- Taxes: As with a car purchase, you’ll have to pay sales tax on your lease. Like interest, this is calculated by adding the monthly depreciation cost to the interest. That amount is then multiplied by the local sales tax rate.
Turning in Your Leased Car
At some point, your lease term will come to an end. Your lease agreement will outline what’s expected of you when your lease is up. At that point, you’ll have several options. They include:
- Trade in for another lease: You can turn your car in and ask for a lease on a new car. This could give you a break on the disposition fee and other costs. You may also be able to negotiate a better deal on a new lease, especially if you’ve established that you’re a customer who pays on time every month.
- Walking away: At this point, you’ll be carless, which means you may have to look into buying a car. You’ll be responsible for all fees, including the disposition fee, if you go this route.
- Purchasing the vehicle: If you’ve had a great experience with your leased vehicle, you may want to keep it. Whether this is a good deal or not depends on how much value is left in the vehicle. The best course of action is to get the buyout price from the leasing company, then compare it to what you’d pay to purchase the vehicle elsewhere.
Leasing a car has its pros and cons, but if you’re willing to shop around for lease deals, it may not be such a bad idea. If you like to drive the latest car models and you can’t afford a car payment on a purchase, a lease could be an option. However, it’s almost always more costly than purchasing the same vehicle, long-term, so it’s important to shop around and understand how much more you’ll be paying.
- Experian: What Is a Car Lease and How Does It Work?
- Policygenius: What Happens at the End of a Car Lease?
- Wall Street Journal: How to Lease a Car and Get the Best Deal
- MoneyShake: What Is the Average Car Lease Length?
- Credit Karma: How Much Does It Cost To Lease a Car?
- Credit Karma: How To Get a High-Mileage Lease
- Car and Driver: What Credit Score Is Needed To Lease a Car?
- Value Penguin: What Insurance Do You Need for a Leased Car?
- Edmunds: Leasing vs. Buying a Car: Which Is Better for You?
- Larry H. Miller Dealerships: What Is The Residual Value of My Lease
- Credit Karma: Car Leasing and Taxes: Things To Know Before You Sign
- Bankrate: Leasing a Car: How To Do It and Mistakes To Avoid
- Real Car Tips: Fees You Will Have To Pay When Leasing a Car
- Credit Karma: How Can I Get Out of a Lease Early?
- Real Car Tips: How To Calculate Your Monthly Lease Payment
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Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.