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

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.

Can I Negotiate the Price of a Leased Car?

How Can I Reduce a Monthly Lease Payment?

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.

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?

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?

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?

How Long Is a Car Lease?

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.

• Acquisition Fee: This is a fee a lessor charges for setting up the lease. This fee varies greatly and can be as much as $1,000. Ask before signing any lease what fees get included in the acquisition fee. You might see destination charges and documentation fees for processing the lease title, license plates, and car registration. The fees remain firm and can’t be negotiated away. However, you can fold them into monthly payments.
• Allowable Mileage: Also called the “mileage cap,” the allowable mileage is the average number of miles per year you can drive the car. The lessor will penalize you for every mile above that number.
• Capitalized Cost: This is the agreed-on selling price of the vehicle plus any fees to be included in the monthly payments.
• Capitalized Cost Reduction: Also called cap reduction, it is any element lowering the capitalized cost. It usually takes the form of a down payment or trade-in allowance.
• Depreciation: The lost value of the vehicle throughout the lease is the depreciation.
• Disposition Charge: This is a charge to clean and dispose of your car at the end of the lease. You may be able to negotiate it away if you buy the vehicle or lease another from the same agency.
• Drive-Off Fees: These include fees and deposits due to begin the lease. Don’t forget that sales tax will be due for your lease transaction. Ask the lessor what fees are included in the drive-off fees. You may be able to negotiate some of the lessor’s tacked-on fees.
• Early Termination: Breaking a lease contract before the end of the leasing period. It will cost you dearly if you want out of your lease early. You may need to come up with a sum of money equal to the remaining payments.
• Gap Insurance: Some leases automatically include gap insurance in the capitalized cost. Your insurance may not cover the entire loss if the car is a total loss through theft or collision. Gap insurance pays for what your car insurance doesn’t pay.
• Lessee: The party leasing the car.
• Lessor: The entity financing the lease. It could be a bank, credit union, or a carmaker’s financial division.
• Money Factor: This is called the interest rate in financing, but it looks markedly different in a lease. As with financing, though, the higher the money factor, the larger the monthly payment.
• Payoff Amount: This is what it will cost you to buy the car at the end of the lease. It should be roughly the residual amount minus any security deposit.
• Term: The length of the lease.

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.