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The basics of a car lease agreement

People looking over a car lease
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Lease agreements are frequently full of specific jargon that first-time lessees may not be comfortable with. When you lease a car, you’re essentially paying the leasing company (or lessor) to drive a car it owns for a set period, usually two or three years.

You will be limited to how much you can drive and what you can do with the vehicle. Leasing a car instead of buying can be a much more expensive option, especially when you consider how fees impact the overall cost.

What is a car lease agreement?

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

But while a lease allows you to drive a new vehicle for less than what you would pay if you were buying, you may end up paying a variety of fees and penalties.

What is in the vehicle financing agreement?

The first sections of your car lease contract will likely be focused on what you are 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 leasing companies assess to arrange the lease. It is generally not negotiable. 
  • Amount due at signing: The amount you will need to pay when you sign. It 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 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 will be charged this fee. The disposition fee covers the costs the dealer incurs to prepare it for resale. You will 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 will be charged if you need to get out of your lease early. Ending a lease early usually comes at a steep cost — and may require you to make all of your payments despite returning the vehicle. 
  • Excessive use: Your lease will show you how many miles you are allowed to drive each year. If you exceed that limit, you will be charged a fee based on the number of miles you drive. It may also reference damage to the vehicle that you will 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 will 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 estimated 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 leasing 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: 

  • Customization: Because the leased vehicle doesn’t belong to you, you are not allowed to make any customizations, such as adding a new stereo system or painting the vehicle. 
  • Early termination: If you are not sure whether leasing is right for you, you will be better off buying. If you terminate the lease early, you will be assessed a fee. 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 and tear. Read this section closely so you clearly understand the condition you must maintain for the car. 
  • Maintenance: The car you are leasing is sure to need some maintenance during the period you are 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 at 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 are essentially replacing your lease that just ended with a new one for a different car. 
  • 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, 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 is 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

There are pros and cons to leasing, but if you have already decided that you want to lease instead of buy, it is 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
Auto loans editor