Leasing a car gives you a vehicle to drive for a fixed number of miles and months. It’s similar to renting an apartment instead of buying a house. There is less long-term commitment involved, but you still have to pay for it.
The monthly cost of leasing a car is often lower than buying it with an auto loan. Drivers save an average of $113 per monthly payment, according to Experian’s State of the Automotive Finance Market report. However, there are a number of downsides to be aware of. Here’s how car leasing works and mistakes you should avoid.
What is a car lease?
A car lease is a way to “borrow” a car instead of buying a new or used car. A car lease typically comes with a three-year or four-year contract. In order to calculate your monthly payment amount, the dealer will analyze the value of the new car versus its residual value (what it should be worth when your lease expires). For example, if you lease a $30,000 new vehicle and the dealer estimates that it will be worth $18,000 in three years, you’ll pay $333 a month to cover the depreciation.
You’ll pay finance charges, too. Like with any purchase involving a loan, the higher your credit score, the lower your interest rate. You’ll also have to pay a small amount of money before you drive off the lot to cover taxes and a range of fees. If you want to lock in lower monthly payments throughout the lease, you can consider putting additional money down.
Leasing vs. buying a car
If you’re comparing leasing versus buying a car, there are pros and cons to each approach.
Pros of leasing:
- Because you’re not paying the entire value of the car, you’ll usually have a lower monthly payment.
- If driving a newer or high-end car is important to you, your monthly lease payments will be more affordable than making a big down payment to buy it.
- With a car lease, you’re usually getting a new car. That can help save on ongoing maintenance costs.
Cons of leasing:
- At the end of the lease, the car is not yours. You’ll have to find a new car or buy out your leased vehicle.
- At the end of the lease, you also may have to pay a vehicle turn-in fee if you don’t lease another car from the dealer.
- Most leases come with a mileage allowance — if you drive more than your allotment, you’ll pay hefty per-mile charges.
Questions to ask before you lease
Before you decide to lease a car, consider your priorities:
- Are you looking for a new or a used car? The monthly payments for a new car will likely be less if you choose to lease.
- How many miles do you drive per year? If you drive a lot, leasing may get expensive.
- Can you take care of the car’s interior and exterior? If you return the car in poor condition, you may incur additional charges.
How to lease a car
If you’re ready to lease a car, follow these steps:
- Do your research. When leasing a car, you have nearly unlimited options. You’ll want to narrow down the type and brand you’re interested in first, factoring in how the price will fit into your budget.
- Visit dealers. Next, visit a few dealers and take some test drives. That will help you narrow down what exactly you’re looking for
- Negotiate the terms of your lease. You’re not only talking about the price of the car when you visit a dealership. Pretty much everything is up for negotiation during the leasing process. The negotiation phase is the only chance you’ll have to get the perks you want in writing
- Maintain the car throughout your lease. Remember that you have to turn in the car at the end of the lease term. If it’s not in great condition, you might have to pay additional charges.
At the end of the lease, you’ll have a few options. You can either turn in your car to the dealer, purchase the car or lease a new car.
Mistakes to avoid when leasing a car
Leasing can lower your payments, but it can wind up being very costly if you don’t pay attention to the fine print. Avoid these five common mistakes if you decide to lease your next vehicle.
1. Paying too much money upfront
Car dealers advertise low monthly lease payments on new vehicles, but you may have to pay several thousand dollars upfront to get that affordable payment. That money covers a portion of the lease in advance.
If the car is wrecked or stolen within the first few months, your insurance company would reimburse the leasing company for the value of the car, but the money you paid in advance likely would not be refunded to you. You’d be out of a car, and that upfront money you handed over to the leasing company would essentially disappear.
It’s recommended you spend no more than about $2,000 upfront when you lease a car. In some cases, it may make sense to put nothing down and roll all of your fee costs into the monthly lease payment. If something happens to the vehicle before the end of the term, at least the leasing company doesn’t have a big chunk of your cash.
2. Not buying gap insurance
If you drive a leased car, you should pay for gap insurance. The “gap” refers to the difference in what you still owe on your lease and the value of the car.
Let’s say your contract states that at the end of the lease, you have the option of buying the car for $13,000. If you total the car before the lease expires, your insurance company will determine the current market value of the car and pay that amount to the dealership, which owns the vehicle.
If the insurance company says that the market value is only $9,000, you’ll probably have to pay $4,000 out of pocket to cover the difference between the lease contract’s residual value and the true market value — unless you have gap insurance. The gap coverage will cover the difference.
Many leases include gap insurance. The dealer may offer to sell you gap insurance, but you may find a cheaper policy option with a traditional insurance company. Regardless, the coverage is well worth the small investment.
3. Underestimating how many miles you’ll put on a car
It’s common for leasing contracts to have annual mileage limits of 10,000, 12,000 or 15,000 miles. If you exceed those mileage limits, you could be charged up to 30 cents per additional mile at the end of the lease.
For example, if you exceed the mileage limit by 5,000 miles, you could end up owing an extra $1,500 (at 30 cents per mile) when you turn the car in at the end of the lease.
To avoid extra charges, know your driving habits before leasing a car. Consider your daily commute and how often you take long trips. If you know that you’ll probably drive more miles than the agreement allows, you could ask for a higher mileage limit. However, that will probably increase your monthly payment, because additional miles will result in greater depreciation.
4. Not maintaining the car
If your car has damage that goes beyond normal wear and tear, you could be on the hook for additional fees when it’s time to return it to the dealer.
If a car has a scratch but the mark is less than the size of a driver’s license or business card, many companies may consider it normal use and probably won’t charge a penalty. If the leasing company considers the damage excessive, it can charge additional fees.
The definition of normal use can vary from dealer to dealer. Your lessor will inspect the car before you turn it in and look for dents and scrapes on the body and wheels, damage to the windshield and windows, excessive wear on the tires and tears or stains in the interior upholstery. Don’t assume that your inspector will be lenient.
Before leasing a car, ask about the guidelines on the lease-end condition. These guidelines specify the types of damage you would have to pay for before you return your car.
If the car is significantly damaged, drivers can expect to be charged full market prices for repairs.
5. Leasing a car for too long
If you lease a car, make sure that the lease period either matches or is shorter than the car’s warranty period. Warranties vary from manufacturer to manufacturer, but they typically last up to three years or 36,000 miles, whichever comes first.
If you keep the car for longer than the warranty period, you may have to consider an extended warranty. Otherwise, you could be responsible for maintenance and repair costs for a car you don’t own while still making monthly lease payments.
If you do plan to lease a car for an extended time, it’s probably better to buy it, says Barbara Terry, a Texas-based automobile expert and columnist.
“If the driver owns the car, he’d have to pay for the car and pay for maintenance, but then he could continue to drive it for several years without having to worry about a required monthly lease payment,” Terry says.
Use an auto lease calculator to figure out whether leasing or buying a car will save you more money over the long haul.
Common lease terms
Some common lease terms and definitions you might encounter when leasing a car include:
- Capitalized cost: The amount of money you will pay to lease a car.
- Closed-end lease: Also known as a walkaway lease. The lender is responsible for any reduction in the car’s residual value at the end of the lease term.
- Depreciation: The rate at which the car loses value over the term of the lease
- Gap coverage: Guaranteed asset protection (gap) insurance covers the difference between the car’s value and how much you owe on the lease.
- Money factor: The lease equivalent of the interest rate, usually expressed as a small decimal, like 0.0015. You can multiply the money factor by 2400 to get the interest rate (3.6 percent in this case)
- MSRP: This stands for the manufacturer’s suggested retail price. This can be a starting point for negotiations of the car’s starting value.
- Open-end lease: You are responsible for any changes to the car’s residual value. So if there is additional mileage, damage, wear and tear that negatively affects the car’s value, you are responsible for the difference in the car’s residual value compared to what was projected when you signed the lease.
- Residual value: The car’s value at the end of the lease term.
The bottom line
Choosing to lease instead of buying a car can be a great way to drive a newer car with the latest technology and features for less money per month. But do your homework, shop around and pay close attention to the terms and conditions to make sure that you get a lease that fits your driving habits and your budget.