What are the basic elements of a car lease agreement?

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Leasing a car instead of buying can have its perks. But once you pick out a car, you’ll be presented with a lease agreement, which is a contract between you and the leasing company.

Unfortunately, the contract may be filled with jargon you may not fully understand. Before you seal the deal, familiarize yourself with the basic elements that make up this type of document. Here’s what you need to know to make an informed decision.

What is a car lease agreement?

A car lease agreement represents a legal contract between you and the company that’s leasing the vehicle to you. In many cases, leasing a car is similar to renting an apartment. The agreement lays out all of the terms and conditions of your contract, including the monthly costs, the length of the lease, restrictions, additional fees and more.

As you’re presented with an auto lease agreement, it’s crucial that you understand what you’re getting yourself into. While a lease offers you the chance to drive a new vehicle for less than what you’d pay if you were buying, you may end up getting slapped with penalties.

How does auto leasing work?

When you lease a car, you’re essentially paying the leasing company (or lessor) for the right to drive a car it owns for a set period of time, usually two or three years. Although it’s possible to lease a used car, it’s more common with new cars.

The payments on a lease are designed to cover the depreciation of the car during that period, plus interest, so they’re often cheaper than an auto loan on an equivalent vehicle would be.

The process of leasing is similar to the process of buying. You’ll visit local dealerships to shop around and compare prices and pick a vehicle, then the dealer’s finance department will draw up a car lease contract for you to review and sign.

Leasing can be a good way to drive a newer model car for relatively little cost. It can also make it possible to ensure that you’re always driving a brand-new or relatively new vehicle, as you can trade in a lease for a new one once you’ve completed your term.

At the end of your lease, you may also choose to buy the car with cash or a lease buyout loan or simply walk away.

However, the major downside of leasing is that you may end up spending more in the long term than you would if you bought a car and used it for many years. Moreover, since you don’t own the vehicle, your use of the car must be in line with the restrictions laid out in your auto lease agreement, which is why it’s important to read that document closely.

What is in the vehicle financing agreement?

The first sections of your car lease contract will likely be focused on what you’ll be expected to pay as part of the deal, including how the monthly payment is calculated. Then it will provide information about early termination, mileage limits, end-of-lease options and more.

Look out for these elements:

  • Acquisition fee: An acquisition fee is the charge that leasing companies assess to arrange the lease. It’s generally not negotiable.
  • Amount due at signing: One of the first sections of the agreement states exactly how much you will need to pay when you sign. That amount includes your down payment, but the agreement will also break down any fees, credits or rebates that factor into the total amount due. For example, trading in another vehicle will lower the amount due.
  • Buyout price: Look for the amount you may be able to purchase the vehicle for — along with any related fees — at the end of your lease period.
  • Capitalized cost: Also called cap cost, this is the selling price of the vehicle, which is used to calculate depreciation and how much you owe.
  • Capital cost reduction: This includes any down payments, trade-ins and dealer rebates that lower the cost amount being financed.
  • Disposition fee: If you decide to walk away from the lease instead of trading it in for another lease or buying the vehicle, you’ll be charged this fee. The disposition fee covers the costs the dealer incurs to prepare it for resale. You’ll often be able to get the fee waived if you sign up for a new lease.
  • Early termination fee: The agreement should explain any fees you’ll be charged if you need to get out of your lease early. Ending a lease early usually comes at a steep cost.
  • Excessive wear and tear: Your lease will show you how many miles you’re allowed to drive each year. If you exceed that limit, you’ll be charged a fee based on the number of miles you drive. It may also reference damage to the vehicle that you’ll need to pay for when the lease is over.
  • Money factor: This helps determine the interest rate on the loan. To find out what your interest rate is, multiply the money factor by 2,400. For example, a money factor of 0.0032 times 2,400 gives you an interest rate of 7.68 percent.
  • Monthly payments: The agreement should state the amount you’ll pay each month and include a detailed breakdown of the factors — including sales tax and estimated depreciation — that were used to determine that amount.
  • Residual value: This is the value of the vehicle at the end of the lease due to depreciation. Cars that depreciate more slowly than others have a higher residual value and lower monthly payments.

Restrictions in the car lease agreement

Part of the purpose of the agreement is to explain the restrictions that are placed on your use of the car. Look for these factors:

  • Customizations: Because the leased vehicle doesn’t belong to you, you’re not allowed to make any customizations, such as adding a new stereo system or painting the vehicle.
  • Early termination: If you’re not sure whether leasing is right for you, you’ll be better off buying. If you terminate the lease early, you’ll be assessed a fee, and the earlier you end the agreement, the more expensive it will be.
  • Excessive wear: Your agreement will likely say that you must return the car at the end of the lease with no more than “normal” wear. Read this section closely so you clearly understand the condition you must maintain for the car.
  • Maintenance: The car you’re leasing is sure to need some maintenance during the period you’re using it, and it might even need significant repairs. Make sure to read the section of your agreement that explains your responsibility for covering these costs.
  • Mileage charges: Your agreement will stipulate a certain number of miles, usually 15,000 or less, that you are allowed to drive each year with no extra charge. It will also state the amount you will be charged per mile if you exceed this threshold.

What happens when the auto lease ends?

You have three options when your lease comes to an end:

  • Trade it in: With this option, you’re essentially replacing your lease that just ended with a new one.
  • Walk away: If you don’t want to lease a new vehicle right away or you’d rather buy your next car, you can return the vehicle and simply walk away.
  • Buy the car: If you like the car you’ve been driving and want to purchase it instead of a different one, you can pursue this option. The purchase price will already be listed in your vehicle lease agreement, so you can shop around and compare prices to determine if it’s a good fit for you. Some lenders offer specialized auto loans specifically for lease buyouts.

As you near the end of your lease term, you may start hearing from the dealership to find out how you want to proceed. Take your time to consider each option carefully and determine the right fit for you.

The bottom line

Leasing a car has its pros and cons, but if you’ve already decided that you want to lease instead of buy, it’s important to know how to read the agreement. Not only will it help you understand how your monthly payment was calculated, but it will also give you information on how you’ll need to handle the vehicle over the term of the contract.

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Written by
Ben Luthi
Contributing writer
Ben Luthi is a personal finance and travel writer who loves helping people learn how to live life more fully. His work has appeared in several publications, including U.S. News & World Report, USA Today, Yahoo! Finance and more.
Edited by
Student loans editor