What does it mean to lease a car? It’s one way to acquire a vehicle in your name. A leased car allows you to rent a vehicle in return for making monthly payments. Leasing a car has many benefits, but it might not be the best option for everyone. Learn everything you need to know about car leasing.
What Does It Mean to Lease a Car?
When you lease a car, you pay monthly to drive a vehicle. At the end of the lease agreement, you return the vehicle to the dealership. Unlike when you buy a car, you don’t own a leased vehicle. Essentially, car leasing is renting a car for a short or long period.
The length of the lease and how much you pay monthly depend on your specific lease agreement. Your lease agreement will require you to make monthly payments. At the end of the lease, you might have the option to buy out the vehicle if you want to keep it. Otherwise, you return the car to the dealership.
How Leasing a Car Works
Leasing a car is easy once you know the steps and what make leasing different from a car purchase. Leasing a car includes:
- Identifying the make and model you want.
- Shopping around and comparing prices from dealerships.
- Negotiate the price (yes, you can negotiate the price of a leased car!)
- Completing a loan application, which includes giving the lending company permission to pull your credit and review of your credit score.
- Deciding the term (number of years) of the lease and choosing the mileage limit.
- Signing a lease contract agreeing to the lease terms.
How Is A Car Lease Different From A Car Loan?
In many ways, a car lease is similar to an auto loan. For example, as the person leasing a vehicle — also known as the lessee — you may have to put cash down for the car, and you’ll make monthly payments just as you would with a typical car loan.
Leases often have lower monthly payments than a car loan — but those lower payments have a downside. Instead of building equity in the car, you’re only paying for the privilege of driving it for a set amount of time and miles.
While you can often apply for car-loan financing through a bank or other third-party lender in addition to a car dealership, it’s uncommon to arrange a car lease through a bank. Instead, you’ll most likely work directly with a dealership or a specialized vehicle-finance company.
At the end of the lease term — typically two to four years — you’ll return the car to the dealership and walk away from the car and monthly payments for good, unless your lease allows you to purchase the vehicle.
Can I lease a used car?
It’s possible to lease a used car. Edmunds recommends working with a franchised dealership to arrange financing on a certified pre-owned car. Examples of franchised dealerships could be BMW or Toyota.
“Lease-here, pay-here” dealerships tend to lease used vehicles to people with bad credit — but these leases are often filled with “gotchas.” It’s generally best to avoid leasing from these types of dealers.
How to Lease a Car
You can lease a car with the following steps:
Compare the Pros and Cons of Leasing
Before applying for a lease, compare its pros and cons. Find out if a lease makes sense for your driving habits and lifestyle. Consider if you want to give up your car at the end of the lease. Compare the costs of the same car if you were to buy or lease it to get a better idea of how much you can expect to pay for both.
Check Your Credit Score
Your credit score is an important part of determining your eligibility for a lease. Checking your credit score ahead of time can help you know what to expect. The average credit score for a lease is between 680 and 739.
The higher your credit score, the better interest rate you’re likely to receive. While you might be able to get a lease with a lower credit score, you’ll usually be required to pay a higher down payment. Improving your credit score before applying for a lease could result in a more attractive monthly cost.
Research Lenders and Create a Budget
Research and compare lenders before choosing one. You want to choose a lending company that offers an affordable monthly payment, which they usually calculate based on the car purchase price and the estimated capitalized cost reduction. A larger down payment can help you lower your monthly car payment.
Choose a Car and Negotiate
You can negotiate the cost of a lease just as you can when buying a new car. Do your research on any vehicles you’re interested in leasing. Consider the average vehicle purchase price and how much other lenders are charging for similar lease agreements. Use this information to negotiate the best price.
Calculate Your Miles
Calculating how many miles you drive each year can help you choose the best lease term. Be realistic regarding the number of miles you drive, and leave room for error. It’s best to overestimate your mileage to avoid expensive overage fees.
Apply for a Lease
Once you find a lender you want to lease through, submit an application. The process of applying for a lease on your next car is similar to the application you’d submit for a car purchase.
The Motor Vehicle Leasing Disclosure Act requires lenders to follow certain rules. One of these rules is they must provide you with a copy of all documents you sign. Review these documents in detail to make sure everything is as you agreed.
How Long Is a Car Lease?
Car leases can be anywhere from two to five years long. The average length of a car lease is 24 to 36 months. How long you lease a car will affect your monthly costs and mileage allowance. Longer leases usually qualify borrowers for cheaper monthly payments.
You also want to choose a lease period that fits your lifestyle. Returning your lease before the lease period is over can be costly, so try to predict when you’ll be ready to exchange it for a new car.
What Are the Requirements for Leasing a Car?
The specific requirements for leasing a car depend on the lender. However, lease requirements usually include:
A Good Credit Score
You typically need a good average credit score to qualify for an auto lease. Fewer lenders offer leases to borrowers with less-than-perfect credit. Also, even though you don’t own a lease, the lender reports your monthly payment to the credit bureaus. This means making late payments or missing payments can affect your credit score.
Proof of Consistent Income
Lenders also require lessees to have proof of consistent income to qualify for a new car. The minimum income requirements will vary based on the lender and the vehicle’s lease or purchase price. You can prove your employment with pay stubs or tax returns.
Proof of Insurance
Leasing companies also require proof of insurance before leasing a vehicle. You must show proof of insurance covering the lease’s entire purchase price. Remember most lease terms require drivers to carry auto insurance for the length of the lease.
Defaulting on your insurance during the lease could void your agreement. The lender might also purchase their own insurance for the vehicle and push the cost off to you.
Valid Driver’s License
Leasing contracts require borrowers to have a valid driver’s license. Whether you lease a new or used car, you must provide the lender with a copy of your driver’s license. Make sure your driver’s license information is up to date and matches your lease application details to help speed up the process.
What Terms Do I Need To Know Before Leasing A Car?
If you haven’t leased before, a car-lease agreement can be full of unfamiliar language. Before taking out a lease, here are some terms to know.
Open-end vs. closed-end leases
If you’re considering leasing, you’ll want to verify if your terms are for a closed-end or open-end lease. With a closed-end lease, you typically don’t pay any more after you return your vehicle — unless it has excessive wear and tear or you went above any mileage limits.
A closed-end lease means you’ve already agreed on how much the car’s value will decrease during your lease term. If the car is worth less than your agreed-upon amount when you return it, you have no additional financial obligation.
With an open-end lease, the future value of the car isn’t in the contract. At the end of an open-end lease, you may get a refund if the vehicle is worth more than expected. But if the car is worth less than expected, you may have to pony up more cash.
Your lease contract can include a number called the gross capitalized cost, which is comparable to the agreed value of the car and services at the start of the lease. The gross capitalized cost includes the value of the car plus the value of any other services and fees defined in the lease.
A related term is capitalized cost reduction. It’s possible to reduce your gross capitalized cost — and monthly payment — by applying a capitalized cost reduction. Capitalized cost reductions are subtracted from the gross capitalized cost to calculate the beginning lease balance — they kind of function like down payments on a lease.
If you trade in a vehicle or put cash down, your gross capitalized cost will be reduced by the amount of the capitalized cost reduction.
Residual value is the value of the car at the end of a lease agreement. A car that holds its value well has a high residual value. You and the lessor will typically agree to a residual value at the start of a lease agreement, and the car’s residual value will be in the contract.
Depreciation is the rate at which your vehicle loses value over time. If you’re leasing, you’ll pay for the depreciation on the vehicle through your monthly lease payments.
The rent charge — also known as the money factor — is the largest cost of leasing a vehicle and is similar to interest. You can figure out your equivalent annual percentage rate, or APR, by multiplying the money factor by 2,400.
There may be a use tax when you take out a lease. In most states, the use tax usually replaces the sales tax that most people pay when buying a vehicle.
Guaranteed Auto Protection (gap) coverage
The lessor may require you to purchase gap insurance, which covers the difference between the amount you owe on your lease and the actual value of the leased vehicle if it is damaged or stolen.
Early termination charges
When you take out a lease, you’re agreeing to pay for the lease for a certain period of time. If you end the lease early, you may have to pay an early termination fee. Your lease agreement should explain what amount you’ll owe if you choose to end the lease before the term is up.
What Happens At The End Of My Car Lease?
When a lease is up, you have two options.
- Buy the car. Most of the time, leases give you the option to buy the car at the end of the lease. If you don’t have the cash to pay for the car, you may be able to apply for a lease buyout loan to buy it.
- Settle the account and walk away. The end of a car lease may be as simple as returning the car to a dealership and walking away. But in some cases you may have to pay if you drove more than a certain mileage limit, which is usually between 10,000 and 15,000 miles a year. The exact fees for excess mileage will be defined in the lease contract. You may also have to pay for excessive wear and tear if you turn in the vehicle in poor condition.
Is Leasing Right For Me?
Even though monthly lease payments are usually lower than car-loan payments, leasing may be more expensive than an auto loan in the long run.
When you take out a car loan, you’ll pay off the car over time. Driving a vehicle you own can reduce your long-term costs since you’ll no longer have a monthly payment once your car loan is paid off. But if you lease a car, you won’t be building equity in a vehicle.
Depending on your desires and lifestyle, it can still make sense to lease instead of buy. Here are a few times to consider leasing.
- You want to drive new cars. If you exclusively lease new vehicles, you’ll enjoy the benefits of a new car without the hassle of selling a used vehicle each time you trade up.
- You don’t want to own a car. If you view car ownership as a hassle, a lease may be a good choice for you. Lease agreements may include service contracts that can make dealing with maintenance and repairs more convenient.
- You need a car for a short time. Perhaps you’re living somewhere short term and need a car. In that case, taking out a two-year lease may make more sense than buying and selling a car.
How Leasing a Car Differs from Buying a Car
As we mentioned earlier, leasing a car is often thought of as a long-term rental, with the main difference being that once the lease is up, the car must be returned to the leasing company, or you may choose to purchase the car from the leasing company.
How does leasing a car work? All lease agreements require you to select a mileage limit, usually between 10,000 and 15,000 miles. The mileage limit is the exact number of miles you are “allowed” to drive per year, which figures into the depreciation of the car’s value over the course of the lease term.
If you know you’ll need more miles, this could add to your monthly payment. If you choose a lower number of miles and go over that amount, you will be charged a penalty for exceeding the mileage limit.
If you purchase a car with a car loan, you will pay your monthly loan payments for a specific length of time that you agreed on with the loan company, however you will own the car when the loan is fully paid-off.
Is Leasing a Car Worth it?
While it’s exciting to purchase a car and think of it as your own, the truth is, if you are purchasing a car with a loan, then you don’t actually own it until the loan is fully paid. During this time the car will depreciate and then you own an older car that is less valuable.
Why lease a car? Many people prefer to lease because leasing allows them to have a brand new car at the end of every lease term, which is generally two to three years.
Which option you choose depends on your unique needs.
Car Leasing Pros:
- You have lower monthly payments with a low — or no — down payment.
- You can drive a better car for less money.
- You have lower repair costs because you are under the vehicle’s included factory warranty.
- You can more easily transition to a new car every two or three years.
- You don’t have trade-in hassles at the end of the lease.
- You pay less sales tax.
- You don’t own the car at the end of the lease (although there is always the option to buy).
- Your mileage is typically limited to 12,000 miles a year (you can purchase extra).
- You may find lease contracts confusing and filled with unfamiliar terminology.
- You’ll pay more in the long run for a leased car than you will if you buy a car and keep it for years.
- You could face excessive wear-and-tear charges. These can be a nasty surprise at the end of the lease.
- You will find it costly to terminate a lease early if your driving needs change.
Mistakes to Avoid When Leasing a Car
Whether you’re new to leasing or have been leasing for years, here are some common mistakes to avoid when leasing a car:
- Paying Too Much Upfront: In the event that your car is totaled or stolen early in the lease period, if you put a large chunk of money down, the insurance company would reimburse the leasing company.
- Not Buying Stop Gap Insurance: Allstate explains, Gap Insurance helps pay off your auto loan if your car is totaled or stolen and you owe more than the car’s depreciated value. Also called “loan/lease gap coverage,” it helps pay the gap between the depreciated value of your car and what you still owe on the car.
- Underestimating Miles: If you underestimate the number of miles you drive in a year, and go over your chose mileage limit, you will be charged a fee-per-mile as a penalty.
- Not Maintaining the Car: Some leasing companies will cover routine maintenance, such as oil changes, in the lease agreement. But even if routine maintenance isn’t covered, you should always maintain the car for safety reasons. This includes rotating the tires, having all of the fluids checked and refilled.
- If major repairs are needed at the time your lease is up, the leasing company could charge a hefty price for making those repairs.
- Leasing the Car for Too Long: Because leases are generally meant to be short-term, if you choose a longer-term lease, the warranty could run out just around the time the car starts to need repairs.
What is the point of leasing a car?
Leasing a car means you’ll have lower monthly payments and you can typically drive a vehicle that may be more expensive than you could afford to buy. On the other hand, if you decide to buy a car, you’ll own it in the end, even if it means you’ll pay a higher monthly loan payment in the meantime.
Is it better to lease or finance a car?
If you love having a new car, a lease might be a good option for you. It allows you to drive a brand-new car every few years. On the other hand, if you don’t mind driving an older car, financing a car is almost always cheaper in the long run.
How much is a lease for a $45,000 car?
Using our calculator, we input a $5,000 down payment, an assumed $25,000 residual value, an interest rate of 7% and a term of 36 months (three years). It resulted in monthly payment of $606 before taxes.
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