Leasing is confusing to many people, and for good reason. The basic premise of leasing is easy to grasp, but the complexities of it can be bewildering. While leasing may be an excellent option for some, you'd better know what you're getting into before you sign on the dotted line. Leasing allows plenty of opportunities to either cheat or defraud a consumer―or at the very least, to make it difficult to get the best deal available.
We've put together a leasing primer to help decode it all.
What is a Lease?
Leasing a car is like renting an apartment. You are paying to use the vehicle, and you will not own the vehicle once the lease contract is over. You may, depending on your contract, gain some equity in a car, but that's still a bit iffy. (See "Types of Leases" below for more information.)
And just like with an apartment lease, you can't decide halfway through to skip town. If you want to get out of your lease early, expect a large early-termination fee. During the first year of the contract, it might even be impossible to end it.
Limitations and Penalties
Even though you don't own the car, you'll need to take responsibility for it while it's in your possession. This means performing the necessary upkeep, such as getting the oil changed or having the brakes repaired. Fortunately, in many cases the vehicle will still be under warranty while the lease is in effect, so you won't have to pay for some of the major repairs.
You won't be able to drive the car to your heart's content, either. If you do, you'll have to pay extra for it. There's a yearly limit, normally around 15,000 miles. You can go past the mileage in a given year as long as your overall mileage total is under the limit when the contract ends. So go ahead and take that cross-country road trip, just not every year.
If you think you can't help but go over, try buying extra miles at the start of the lease. Or, use capitalism to your advantage and negotiate to have extra miles factored into the mileage allowance at no extra cost.
While leasing companies expect some wear on their vehicles, they want the cars returned in good shape. Get a description in writing of what the leasing company thinks is excessive wear or damage, if it's not already spelled out in the contract. If you didn't take tender loving care of the car during the lease period, fix what you can before returning the car.
Leasing payments are much lower than loan payments for a similar vehicle. Why? Your lease payments are merely covering the difference between the current cost of the car and the expected value of the car at the end of this lease, or the "residual" value. In other words, you're paying for the depreciation, plus a leasing agent fee.
Thus, cars that hold their value well or don't depreciate as rapidly as others make for better lease deals.
Capitalized Cost (Lease Price)
Remember that just like a car buyer, you have the freedom to negotiate the price of the vehicle with the dealer when you lease. The agreed-upon selling price is known as the "capitalized cost" or "lease price." The lower you can get the capitalized cost, the lower your monthly payments will be.
Types of Leases
There are two types of leases: open-end and closed-end. Closed-end leases are what that most consumers have. At the end of a closed-end lease, you simply return the car to the dealer. Of course, you'll have to pay any extra fees you might owe, such as for excessive wear or mileage.
In a closed-end lease, the leasing company assumes the risk of the car losing value, which makes it better for the consumer. It's also why these leases are more expensive. For instance, if you return the car at the end of your lease and it's gone down in value more than predicted, the leasing company absorbs the loss. On the other hand, if the actual value of the car is more than the residual price, you can buy the car from them at the lower residual price when your lease is up―that is, if your contract gives you the option to buy it. If it does, you may then keep the car or try to sell it for a profit.
On the other hand, in an open-end lease, the consumer assumes the risk. If a car loses value, it's up to you to pay the difference between the stated value and the actual value. Ouch!
That's why an open-end lease means cheaper payments upfront. Open-end leases are generally used by businesses, who are better able to handle the possible financial hit at the end of the lease.
If the two types of leases have anything in common, it's the fees. Many, many fees. Before you drive off the lot, be prepared to write a large check to the dealer. Unlike a car loan, lease payments are due at the start of each monthly cycle, not the end. So be prepared to pony up your initial monthly payment right away. You will also owe other charges, such as taxes, licensing fees, destination charges, processing fees, a security deposit, your down payment, and possibly your first-born son.
Sometimes leases require only a small or no down payment. Before you buy a new set of golf clubs with your savings, remember that making a down payment will lower your monthly payments. Also, keep in mind that you won't get your down payment back at the end of the contract. Do some math and figure out which is cheaper at the end.
Here's where you can get a big break. When you buy a new car, you pay tax on the entire value of the vehicle. With a lease, in most states, you'll just pay for the value of the car while it's in your possession―in other words, you'll pay tax on the amount of the lease. And you can also spread this tax payment over the length of the lease, instead of paying it all at the beginning.
Gap Insurance and Regular Insurance
Many dealers require gap insurance. We're not talking about that store in the mall. This insurance pays the difference between what the car is actually worth and how much you owe on the lease, should the car be destroyed or stolen. However, many leases include this coverage without any additional fees.
You'll also have to maintain insurance on the car. The minimum coverage limits will be listed in the contract.
Before You Commit
Keep in mind that if you have a poor credit rating, it might be more of a problem to obtain a car lease than a car loan. Follow the mantra of financial experts before applying for major credit: check your credit report before you go in. Fix any inaccuracies and you'll have smooth sailing.
Like car loans, leases come in different lengths. However, be sure that the longer leases don't carry the car past the warranty cut-off, so you won't have to pay for more repairs. It's possible to have the lease extended on a month-to-month basis when the contract ends. But be careful that the leasing company doesn't change the terms of the contract.
You don't have to use the dealer's leasing agent, either. Feel free to do business with banks, credit unions, or other leasing companies.
Leasing a Used Vehicle
You can get a lease on a used car, too. Because a used vehicle has probably already been through its steepest depreciation period, getting a used-car lease can be a smart move financially. However, it's a bit harder to arrive at an accurate residual value for a used car, so just make sure that the value is reasonable to you. And you don't want to take out a lease on a car that has a lot of age, as too many headaches could ensue. Do your homework on all the best models first.
Reading a lease contract can be more confusing than reading a tax return. (Wait, that's an exaggeration. Nothing's that confusing). Instead of sweating it out in the dealer's office, ask the leasing company for a blank contract a few days before you're set to close the deal. Spend some quiet time examining the contract thoroughly and ask questions about anything you don't understand.
Also, like anything else, leasing contracts sometimes contain errors. You need to correct these errors before you sign the contract. If you catch them after you've signed the lease, you will have to throw yourself at the mercy of the leasing company, because you are legally bound to follow the terms of the lease.
If you're unsure whether leasing is for you, consult our Lease or Buy? section for some helpful direction with this decision. And do spend time on this decision, because you'll be stuck with the consequences of it. If you'd like additional information on leasing, there are also plenty of helpful online sites that explore seemingly every aspect of leasing. Among them: