Leasing Guide: What to Know About Leasing a Car
Love to drive brand-new cars? Then leasing may be right up your alley—if you're fine with some of the rules that go along with it.
When it comes to getting a new car, the first thing most people often consider is buying a vehicle, but you also have the option of leasing a car. If you've never leased a vehicle before, it's important to know that the process differs in several ways compared to buying.
Here's what you should know about leasing and when this option may make the most sense.
What is Leasing and How Does it Work?
In basic terms, leasing is the equivalent of a multi-year car rental. With leasing, you apply for financing through the dealership. Once you're approved and after you select your vehicle, you sign a contract with a dealer to rent the car for a specific term, which could be either a 24-, 36-, 48-, or 60-month term.
A car lease often comes with rules around how many miles you can drive during your lease term. For example, you may have a 36-month lease that caps your miles at 15,000 miles a year. If you go over this mileage, you'll have to pay extra fees.
The car's residual value—which is mostly based on the car's manufacturer suggested retail price (MSRP) minus depreciation and other factors, such as the car's condition, make, and model—determines your monthly leasing costs, in addition to lease fees and taxes. These fees, along with a higher initial car price, are how dealers make a profit on a leased vehicle. Add-ons like additional warranties can also increase dealers' margins on leased cars.
Leasing a car may or may not be less expensive than buying, depending on the type of car you lease, your lease term, your credit score, and how well you're able to negotiate the initial sales price.
What are the Different Types of Car Leases?
Generally, there are two main types of car leases:
- Closed-end leases: this is the most common type of car lease. You agree to lease the car for a set term and certain mileage limits, and return it at the end of the leasing period. There's no obligation for you to purchase the car at the end of the lease, but if you exceed the mileage limits or there's excessive wear and tear on the car, you'll have to pay additional fees
- Open-end leases: open-ended leases are the exact opposite of closed-end leases. This type doesn't have a specific end date but rather a flexible time window in which you can return the car without paying additional penalty fees. An open-end lease also has flexible mileage limits, but the downside is that you'll pay higher leasing costs for this benefit
What are Your Options at the End of a Lease?
At the end of the leasing period, you have two options: return the car or buy it outright.
If you have a closed-end lease and decide to purchase the car, the purchase price will be based on the car's residual value. For example, let's say you leased a $30,000 car and the dealer sets the residual value at 60% of the MRSP. This means you'd pay $18,000—60% of the MRSP—to purchase the car at the end of your lease.
With an open-ended lease, the purchase price of the car isn't as clear cut. With this arrangement, the amount you owe will be the difference between the car's residual value and its actual value at the end of the lease term. This means you could be on the hook for covering any additional depreciation beyond the dealer's initial projections for the car's residual value. This is why it's so critical to stay within the mileage limits of your lease and avoid damage to the car (or at the very least, repair the damage before returning the vehicle). Any damage or excess mileage can cause additional depreciation, which will result in additional fees and a higher purchase price.
Leasing vs. Buying: Which is Right for You?
One benefit of leasing vs. buying a car is that you often don't have to make a down payment as long as you have good credit. You can choose to make a down payment, which will lower your monthly lease payments, but it isn't required.
Leasing a car can be less expensive than buying, especially when you factor in the rising new car prices in the market. It also allows you to get a newer vehicle without the huge upfront costs and time spent getting approved for a loan and issuing a down payment. Another advantage is that your maintenance costs are likely to be less. People often lease brand-new or relatively new cars, which don't have many of the maintenance issues you'd experience with an older vehicle.
However, the downside of leasing a car is all the additional taxes and fees you'll pay—and potential overages—for an asset that you may never own. There are also restrictions on how many miles you can drive, and you have to worry about bringing the car back in pristine condition. With your own car, you may delay fixing a minor dent or scratch, but with a leased car, these things can be costly in the form of excess wear-and-tear fees.
If you end your lease early, you'll also pay early termination fees and could have to pay out the remainder of your lease. You might have the option of transferring your lease, depending on the terms of your agreement. With this option, the new lessee would have to have good credit to be approved by your lender. If they are approved, you can transfer your lease to them. However, you may still have to pay a lease transfer fee and find a suitable person to take over your lease. Third-party services are available to make these connections, but this will require some of your time. In this way, leasing a car can be less flexible than buying a car.
Making the Decision to Suit Your Needs
Ultimately, a lease can be a good option if you prefer to always drive a newer vehicle. You can get into a new car with the latest features and technologies but without huge upfront costs, and you likely won't have to worry about maintenance or upkeep. Depending on your individual needs, this could be the ultimate win-win.