Car Leasing Guide: How to Lease a Vehicle – Kelley Blue Book

by | Feb 10, 2023 | Advice

[ad_1]

Car Leasing Guide

Lease a Car: Quick Tips

  • Considering your annual mileage is a crucial step in how to lease a car.
  • Negotiate when leasing a car to reduce the capital cost and money factor, which will lower your monthly payment.
  • Get familiar with leasing jargon because some terms aren’t used in traditional auto financing.
  • Establish and stay within a budget. Remember that you are responsible for maintenance and insurance expenses for a leased car.

At first blush, car leasing seems like a grand idea. After all, you can get more car for the same monthly financing payment. Who wouldn’t want that? Well, there’s much more to weigh between financing and leasing than getting more car for your buck. Although, that is the primary reason people lease a vehicle.

Among the other reasons people lease is the thrill of that new car smell, assuming you lease a new vehicle. Some folks simply like the idea of driving a new car every two or three years. Leasing also streamlines writing off your vehicle as a business expense at tax time.

Another reason to lease is that sometimes the carmakers offer sweet leasing deals that aren’t available to those financing a car purchase. Repeat leasers also always drive a car that’s usually under a factory warranty. And finally, when the lease expires, you don’t need to negotiate a trade-in value or go through the selling process. You just hand over the keys and walk away. Easy peasy, right? Well, usually.

Our guide will walk you through vehicle leasing from what to know before you leap, whether negotiable or not, and what to know about buying a car versus leasing one, including pros and cons.

What Is Car Leasing?

Lease a car or buy one; what’s the difference? Car leasing is like renting a vehicle for a contracted period, except it’s a longer term. Unlike financing a car purchase based on you eventually owning the vehicle, leasing is like a long-term rental. You are locked into the deal for a contracted number of months and a monthly payment.

However, instead of paying down a loan and building equity, you are paying for the car’s estimated lost value (depreciation) during the term (length) of the lease. You are paying for that and the interest on the money borrowed to underwrite the lease.

Typically, consumers sign a closed-end lease. There are also open-end leases. You can read about the differences in the section below. Closed-end is the type of lease covered here.

What Do You Need To Know Before Leasing?

Arguably the key concern when considering car leasing is how many miles you drive yearly. According to the United States Department of Transportation’s latest figures from 2020, most Americans drive an average of 12,724 miles yearly, and that’s down from 14,263 in 2019. Average annual miles will almost certainly return to pre-pandemic figures.

Leasing Mileage Cap

Regardless, signing a lease binds you contractually to stay within an established mileage limit. That limit, or mileage cap, is averaged over the number of years in the agreement.

Depending on the lease, agreements range from 10,000 miles per year to as many as 15,000 miles per year. Whatever the limit, the leasing company will penalize you for every mile above the limit. Generally, that penalty can be between $0.12 to $0.30 per excess mile. At $0.30, that works out to $300 for every 1,000 miles over the limit. It can add up, so be sure you know how many miles you drive and what the per-mile penalty is before signing the lease.

What Is the Money Factor in Leasing?

When you finance a car, you must also pay for the money you borrow. What you pay is called interest, displayed as a percentage (3.0%, 4.5%, and so forth). You need to know the rate of interest you will be paying. The higher the interest rate, the higher your monthly payment.

When you lease, you must also pay for the money the lessor used to buy the car. In leasing, however, the interest is called the money factor. It’s calculated and displayed differently (0.0010, 0.0023, and so forth). How in the world do you know the interest rate on a lease, right?

To translate the money factor into a more easily understood form, multiply it by 2,400. So, 0.0023 x 2,400 = 5.5%. We know: Why don’t they just say that?

Can I Negotiate the Price of a Leased Car?

Yes, and it’s wise to negotiate a vehicle lease. Like negotiating the price when you buy a car, you can do the same with a lease. However, if you accept a manufacturer’s incentive or dealership deal, you may not get the opportunity to negotiate other line items in the vehicle lease. But you can try.

TIP: Dealers could be more willing to negotiate the price of your vehicle lease before a new model arrives or before the end of the model year for the car you’re interested in leasing.

How Can I Reduce a Monthly Lease Payment?

  • Reduce the capital cost by negotiating a lower vehicle purchase price.
  • Ask for a lower money factor. If your credit score is more than 750, go for a lower rate.
  • Put additional money down or, if there’s a trade-in, negotiate for a higher trade-in value.
  • Shop other dealers for a better deal.

What Are the Negotiating Points in a Lease?

  • The vehicle purchase price is framed as the capital cost.
  • The down payment.
  • The trade-in value.
  • The money factor.
  • The disposition fee.

What Can’t You Negotiate in a Lease?

  • Residual value is generally set in stone. You can give it a try, but don’t expect much.
  • Acquisition fee. This is a charge that lessors rarely budge on.

Who Is Responsible for Maintaining a Leased Car?

The leasing company expects you to maintain your leased car carefully. That means following the maintenance schedule outlined in the owner’s manual. The good news is that many new vehicles come with some sort of free maintenance plan.

At the end of the leasing period, an agent of the leasing company will inspect the vehicle for any damage beyond “normal” wear and tear. Determining what is normal is entirely up to the inspector. If the inspector decides any damage is beyond normal wear and tear, you will get charged for it.

Who Is Responsible for Insuring a Leased Car?

You are responsible for insuring your leased car. The leasing company dictates the type of car insurance coverage you must carry for the vehicle. Determine what those amounts will be, and contact your automobile insurance agent to establish the annual premium before you lease.

What if I Want Out of My Lease Early?

It bears repeating: A car lease is a binding contract. The leasing company sets the monthly payments based on the lease length established in the agreement. If, for some reason — any reason — you want or need to bail on the lease early, you will pay the penalty for doing so.

At worst, that penalty may require a balloon payment to cover the remaining outstanding payments. You can’t just return the leased car or sell it to pay off the leasing company. It’s not your car, and you have no equity in it.

Market conditions these days make it possible to negotiate with a dealership if you’re planning to buy a car. Or, because the used car supply is tight, dealerships may be more willing to make a deal to get you out of your lease early.

Brokers with auto lease transfer companies like swapalease.com can also attempt to connect you with a deal that lets you sign over the lease to someone else.

Before making any choices, weigh all your options to determine the best option.

How Does My Credit Affect Car Leasing?

Credit score information for leasing

As with financing a car purchase, a leasing company will use your credit score and history to determine whether or not it will lease to you. Roughly 83% of new car leasing during the first three months of 2021 was to borrowers with a credit score above 660. This is according to the national credit bureau Experian. It also found that the average credit score for leasing during that period was 734.

If your credit score is 501 to 660, you may be able to find a lender willing to lease to you but expect to put down a hefty down payment. Also, you can expect a higher-than-average interest rate with a lower credit score.

Leasing a car generally requires better credit than financing. When leasing, you have little or no skin in the game. All you stand to lose if you stop making your lease payments is whatever down payment you made.

You don’t and never will have any equity in a leased vehicle. You are essentially renting it, remember? Leasing companies know you have little to lose. Consequently, they tend to be pickier when evaluating lessees rather than buyers.

RELATED: Can I Buy a Car with Poor Credit History?

Car Leasing vs. Buying

Whether you lease a car or buy and finance your automobile, you must make a monthly payment. In most cases, both will also require some amount of money upfront. When financing, it’s usually a down payment of some sort.

With leasing, you may have to put up a security deposit, the first month’s lease payment, a fee for arranging the lease (see acquisition fee below), a down payment, or some combination of those. In either case, there are also car title and registration fees.

Pros of Leasing

  1. Lower monthly payment. Because you are only paying for the estimated depreciation while driving the car and not the entire purchase price, monthly leasing payments tend to be lower than financing payments. It simply means your money will go farther leasing a car than financing one. A lower monthly payment is the top reason people give for leasing. It isn’t the best reason, but it is the most common.
  2. New vehicle every few years. Another perk of leasing is the freedom to drive a new car every two or three years with no strings attached. A side benefit of having a new car every few years is you probably will always have a vehicle protected by the factory’s new car warranty. There may even be a free maintenance warranty for a portion, if not all, of the lease. And, every couple of years, you can have a car with the most up-to-date technological advances and safety features.
  3. You can walk away at the end. At lease end, you don’t need to worry about the hassle of selling the car or negotiating its value as a trade-in. You drop the keys on the lessor’s desk and walk away. That is if you want that.
  4. Buy the car for less. Here’s some excellent news: If you still like the car at the end of the lease, you can buy it. Because the leasing company estimated what the car would be worth at the end of the lease (the residual value or residual), they may have guessed wrong. If they underestimated the car’s worth at the end of the lease, you could cash in by buying that car for less than the current market value. It’s wise to do this in a tight market when supply struggles to meet demand.
  5. Used car leasing is an option. Some dealerships offer leases on used cars, with some manufacturers offering extended used car leases on vehicles up to 10 years old.

RELATED: End of Lease: What to Do During the Chip Shortage

Cons of Leasing

  1. No equity. Yes, the idea of driving a new car every few years with the benefit of always being under warranty is tempting, as is that lower monthly payment. Sadly, though, it means you will never build any equity. What you pay for with a lease is the depreciation. A car will lose roughly 35% to 40% of its value in the first three years. At the end of the lease, you won’t have a thing to show for those two or three years of payments.
  2. Mileage requirements. Driving a leased car is like counting calories to lose weight. Every mile you drive counts. Every lease comes with a mileage limit. It may average out as low as 10,000 miles per year, although 12,000 miles is more likely. You may be able to find a lease with a yearly cap of 15,000 miles. There are even some more expensive high-mileage leases on the market. You’ll pay more per month but may avoid getting slapped with a mileage penalty at the end of the lease. That penalty is usually about $0.25 per excess mile. If you do a lot of driving, that can add up.
  3. Responsible for damage and repairs. The leasing company will hold you accountable for anything beyond its definition of normal wear and tear. You will be on the hook for any repairs the lessor deems over and above normal. Suddenly, with the excess mileage fee and damage fee, returning that leased car isn’t the easy-peasy experience expected.
  4. Pay hefty penalties if you cancel early. Suppose some change in your life creates the need to get out of the lease early. Good luck. You may find yourself faced with owing a balloon payment equal to the outstanding payments on the lease. At the very least, you will have to pay some sort of stiff penalty. There are online companies like swapalease.com, brokering deals between people who want out of a lease and people willing to pick up a lease. But, such brokered deals will cost you, too.

Pros of Buying

  1. Ownership. The top advantage to buying versus leasing is that the vehicle is yours when the loan gets paid off in four to six years.
  2. Sell or trade-in for another vehicle. There will be value you can cash in by selling or trading it in as a down payment on another car. It’s an asset. Of course, you can always decide to drive it until the wheels fall off. No payments for another five years or more is a pretty good perk. Especially when you consider by year four, the repeat lessee is paying for the depreciation on a second new car and still gaining zero equity.
  3. Easier to get out of a loan than a lease. Getting out from under your car loan is much easier than breaking a lease. As long as you pay off the loan, you can sell or trade your car anytime.

Cons of Buying

  1. No big down payment. Specifically, if your credit is a bit sketchy, you may want to put down a larger down payment of around 20% if you want better odds of getting approved for loan financing. That would be $7,500 on a $30,000 car. Leasing would allow you to keep at least some of that up-front cash.
  2. Higher car payment. While it’s always a smart idea to own your vehicle, your vehicle lease payments will typically be lower than new car payments for the vehicle.
  3. Risk of being upside down. Depending on the length of the loan, depreciation, and the way interest gets calculated, you may owe more than the vehicle is worth until the last year or so of the loan. By that time, the car warranty may well have expired, too. Not only do you have to continue making payments on a 5- or 6-year-old car, but you may have to pay out of pocket for any repairs.

The Differences Between Leasing and Buying

You can draw some fairly strong contrasts between vehicle leasing and financing. Each offers a set of advantages and also disadvantages. Short term, leasing a car will cost less. However, two leases will cost more than buying one car in the long run. And at the end of the loan term, the vehicle will be paid off, and whatever value the car retains will be yours.

Here are some other stark differences.

Leasing

  1. Monthly payments: Leasing payments are almost always lower than financing payments on the same vehicle.
  2. Early Termination: You will pay a hefty fee if you want to end a lease early.
  3. End of term: Although you may owe some penalties, you can just hand the car back to the lessor at the end of the lease.
  4. Mileage: A lease restricts the annual mileage. Exceeding that mileage will cost you big.
  5. After-market: A leased vehicle is not yours to do with as you wish. Any alteration will cost you.
  6. Taxes: Leasing a vehicle allows you to write off the monthly payments as a business expense if you’re eligible.
  7. Warranty: Most leased vehicles come with a warranty that will likely cover your car for the duration of the leasing period, saving you money should something happen to it.

Buying

  1. Monthly payments: For the same vehicle, financing payments will almost always be more than leasing.
  2. Early Termination: You can sell or trade in a financed vehicle anytime, as long as you satisfy the loan balance.
  3. End of term: When the loan gets paid, the car is yours to keep, sell, or trade at a dealership.
  4. Mileage: There are no mileage limits with a financed car.
  5. After-market: Financing a car allows you to make it yours. Take care not to void the warranty. Otherwise, customize it to your heart’s content.
  6. Credit: If you have bad credit, you will likely need to come up with a more significant down payment to get approved.

What Are the Types of Leases?

Leases aren’t one size fits all. The leasing concept doesn’t vary, but the contract details do.

What Is a Closed-End Lease?

A closed-end lease is the most common form of leasing. Sometimes called a “walk-away” lease, it sets firm terms, allowing the lessee to walk away at the end of the lease. All variables like the length of the lease, monthly payments, and the mileage cap are established in the leasing contract. As long as the contract terms get met, the lessee can just drop off the car at the end of the lease. The lessee also has an option to buy the vehicle at a predetermined value.

What Is an Open-End Lease?

An open-end lease is a bigger gamble for the lessee, who assumes more of the risk. Typically, that lessee is a commercial enterprise or business. The leasing company still sets a residual value and the monthly payments. Luckily, open-ended leases usually have more flexible mileage options than their closed-ended lease counterparts. However, unlike a closed-end lease, it’s the lessee taking the hit if the residual value at the end of the lease is less than the vehicle’s actual market value. The lessee must pay the difference.

What Is a Single-Pay Lease?

Also called a one-pay lease, this is a lease in which you pay the entire run of monthly payments upfront. There are two primary reasons for going this route. It usually reduces the interest or money factor rate. You wind up paying hundreds less than if you were to pay monthly. If your credit is questionable, a single, up-front payment may motivate a leasing company to take a chance on you.

Can I Lease a Used Car?

Yes, you can lease a used car. Most dealerships offer leasing incentives on their certified pre-owned (CPO) vehicles. These are gently used, newer model cars with factory warranties and other CPO benefits.

How Long Is a Car Lease?

You may find carmakers offering leasing specials of odd durations. An example: Instead of 36 months, they might offer 39 months. But generally, leases are for 24 or 36 months. You can, however, find leases out there for longer terms. As with financing, the longer the lease term, the lower the monthly payment. That difference, though, may not be much.

Can a Car Lease Be Extended?

Say you haven’t found a replacement vehicle and are at the end of your lease. Is there a way out? Yes, most lessors will gladly extend the lease on a month-to-month basis or for a fixed number of months. You will have to continue making the monthly payment. Also, in the case of a multi-month extension, you may have to sign another contract.

Is it Possible to Lease a Car for One Year?

It is possible to lease a car for one year. But why would you? A vehicle depreciates as much as 30% by the end of the first year. Because your monthly payment gets based on depreciation, that one year will be wildly expensive. You might do better with a long-term rental car. It’s worth checking out. Another idea you could try is a club. These are offered by luxury car club leasing companies and sometimes by manufacturers. The clubs allow members to drive new models for short periods. They usually include insurance and don’t require a long-term contract.

What Are the Key Leasing Terms I Need To Know?

We have been using some reader-friendly shorthand in this guide, but here are the formal leasing terms you should understand.

How to Lease Your Car

For the most part, the shopping process for leasing a car is about the same as shopping for a vehicle you plan to buy. Research is the key. Other steps to take include:

  1. Check your credit score. A credit score under 600 will be a very tough sell. When your credit score is low, you need to make a larger down payment to get approved. If your credit score is higher, it makes for a lower money factor.
  2. Crunch the numbers. Figure out how much cash you can pay upfront. Some deposits and fees must be paid when you sign a lease, and many are not negotiable. The lessor may also demand a down payment.
  3. Determine your average annual mileage. Your lease will require you choose an average yearly mileage cap of 10,000 to 15,000 miles. Be realistic about your driving habits. You will pay a penalty for every mile over the cap.

What To Look For in a Vehicle to Lease

Find a model that retains its value. Some brands of vehicles simply retain more value as they grow older. Brands like Subaru, Lexus, Jeep, and Ram tend to keep much of their value through the years. Value retention is important when you buy a vehicle, but not until you sell it or trade it in. Value retention in a leased vehicle is important because the more value a leased vehicle is expected to retain, the lower the monthly payment.

Questions To Ask Before Signing a Car Lease

Here’s a list of questions to consider asking the dealership or other lessor before you leap.

  1. What is the residual value for the car I’m leasing?
  2. Once the lease ends, what is the price I can buy the car for?
  3. What is the money factor? If you don’t want to do the math, ask for it in percentage form.
  4. What is the monthly payment grace period?
  5. What is the delinquent fee for a late payment?
  6. Will I be charged any other fees at the end of the lease?
  7. What are the penalties for early lease termination?
  8. What is normal wear and tear?
  9. How much do you charge per extra mile driven?

Related Articles About Leasing a Car:

Editor’s Note: This article has been updated since it was originally published.

[ad_2]

Source link