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Car leasing is a popular alternative to buying a car, especially for people who don’t want to commit to a long-term loan. The lease itself is a contract that allows you to drive a new car for a predetermined amount of time, after which you’ll return it to the leasing company or dealership. The contract stipulates that you’ll make periodic payments on the car until the lease is over, and you won’t own it at the end of the term.
What is a car lease?
A car lease is a contract that allows you to drive a new car for a set short period — typically three years — after which you’ll return it to the dealership. Payments are made on a monthly basis, and you’ll have to buy the car when the lease ends if you don’t want to turn it in.
You’ll have limited mileage, and if you exceed the limit, you’ll owe extra fees. You’ll make a payment when the contract starts, and you’ll need to pay additional fees when the contract ends, including a disposition fee.
In essence, a lease allows you to rent a car, rather than buying it. But it comes with a handful of fees at the beginning and end of the contract.
How does leasing a car work?
Before you decide whether leasing is right for you, you’ll need to understand exactly how it works. The dealer or leasing company buys a car. You then agree to pay for your time using the car.
During the lease, you’ll make regular payments to the leasing company. Since you’re not paying off the full price of the vehicle, your payments will be lower than if you bought the car and took out an auto loan.
When the lease ends, you’ll return the car to the leasing company. If you decide to buy the car, you’ll likely pay the residual value. The buyout price is determined ahead of time, and included in the lease contract.
If you decide to lease another car instead of buying the vehicle at the end of the lease, you may not be charged certain fees, like the disposition fee.
If you violate the terms of your lease, you’ll face a penalty. For example, if you drive over the predetermined mileage limit, you’ll owe an excess mileage fee that can be expensive. You’ll also pay an excess wear-and-tear fee if the car has damage that exceeds what’s acceptable.
The pros and cons of leasing a car
Leasing a car comes with a number of benefits and drawbacks.
- Lower monthly payments: Because you’re only paying for the use of the car during the lease period, rather than the full purchase price, you’ll usually get a lower monthly payment.
- The ability to upgrade: A lease typically lasts three years, meaning you can get a new car every few years.
- Maintenance and repair coverage: If you lease a new car, it will likely still be covered by the manufacturer’s warranty.
- A limit on mileage: You have to abide by a mileage restriction when leasing a car, and if you go over the limit, you’ll have to pay fees.
- No equity in the car: When the lease ends, you have to return the car and you won’t have any equity to use toward a down payment on another vehicle.
- Extra fees: If you turn in your car after the lease ends, you may face fees for wear and tear and for the dealer to prepare it for retail.
What is the difference between a lease and a loan?
A car lease is a long-term rental, and you pay rent for use of the car. A car loan is when you borrow money from a financial institution for a certain period of time and then you own the car.
With a car loan, you’ll pay off the car over time and build equity in the vehicle. With a lease, you’re only paying for the privilege of driving the car for a set amount of time and miles. When the lease ends, you’ll either return the car to the dealership or buy out your lease if you decide to keep the car.
Regardless of whether you lease or buy, you will need to carry insurance. In fact, proof of insurance is typically required upon applying.
The bottom line
It’s important to do your research before committing to a lease. Make sure you understand the terms and conditions of the lease, especially the mileage restrictions and wear-and-tear policies — these restrictions might make it difficult to return the car without fees if you drive a lot or don’t take good care of it.