AutoWeb answers some of the most common questions about vehicle leasing.
What is leasing?
Leasing is a method of financing a new vehicle. Leasing is similar to renting in that the “buyer” (technically called a lessee) essentially pays for use of the vehicle rather than pays for the vehicle itself. Leases generally offer lower downs and monthly payments than financed purchases but less flexibility in terms of how long you keep the car and how far you drive it.
What is the difference between leasing and buying?
When you finance the purchase of a car, you are taking out a loan and paying it off over time; when the loan is paid in full, the vehicle is yours. When you lease, you pay for your use of the car for a predetermined amount of time and mileage. Lease rates are based on the difference between the price of the car when new and the residual value (the predicted value at the end of the lease). Car leases commonly last two to three years; though longer leases are available, they generally aren’t a good idea, as the car will be out of warranty (repairs are the lessee’s responsibility) and suffer from a lower residual value that will increase out-of-pocket costs.
Why are monthly payments lower on a lease than a purchase?
Purchase payments comprise the full price of the vehicle plus interest; lease payments are based on the difference between the negotiated price of the vehicle and what the vehicle is expected to be worth at the end of the lease period (in other words, the depreciation) plus interest. A greatly simplified example: If you buy a $30,000 car and finance it for 36 months, you’ll pay out $30,000 (for simplicity’s sake, we’ll ignore interest charges). At the end of three years, you’ll own a car worth, say, $18,000. Your total outlay will have been $30,000, and if you sell the car for what it’s worth, you’ve paid $12,000 to drive the car for three years. If you were to lease the same car for 36 months, your payments would be based on the depreciation ($30,000 – $18,000 = $12,000), so your lease payments will total around $12,000. (Again, we’re ignoring interest.) At the end of the lease you turn the car in. Your outlay is lower, since you are not paying off the principal on the residual value. In some cases, the total out-of-pocket costs on a lease may be lower than buying, financing and selling the vehicle.
What are the advantages of leasing?
Because leasing is based on the depreciation of the car over the term of the lease rather than the purchase price, lease payments are usually significantly lower than purchase payments. Cars that hold their value well may have particularly attractive lease rates. Leasing can be a good option to buyers who like to get a new car every few years, because they do not need to worry about trading in the car or selling it and using the cash as a down payment; they simply turn in the car and lease a new one.
What are the disadvantages of leasing?
Leases have limits on the total mileage put on the car (since mileage affects the car’s residual value), and terminating a lease early may be prohibitively expensive, since cars lose their value at a rapid rate when they are new. Since the car must be turned in at the end of the lease, a lessee must buy or lease another car at the end of the term; there’s usually no option to hold on to it a little longer unless the lessee buys the car outright at the end of the lease. And negotiating on a lease can be more complicated, as there are several financial factors in addition to the finance-purchase basics of price, interest and trade-in. (See “Lease Terms Defined” for an explanation of some of these extra factors.)
Can I negotiate a lease?
Yes, there is room for negotiation in a lease. You will be negotiating primarily on the monthly payment, the term (length) of the lease, and the mileage allowance. The negotiable financial elements include the capitalized cost, the bulk of which is the price at which the dealership will sell the vehicle to the leasing company; you can haggle on this amount as you would a purchase price. Some fees, such as the documentation and disposition fees, may be lowered or eliminated. The acquisition (bank) fee is usually fixed, but some dealers will add a mark-up to these fees, which may be negotiated or eliminated. The money factor (essentially the interest rate for the lease) is usually not negotiable, but dealers may mark up this number (just as they mark up interest fees), which can be negotiated or eliminated, or they may be able to find a leasing company with a lower money factor.
Are there tax advantages to leasing?
Businesses can deduct monthly lease payments from their taxes; doing this as an individual is a bit sketchy, and in the interest of keeping our lawyers happy, we’ll advise you to consult your tax professional. However, in most states lessees are only required to pay sales tax on the lease payments rather than the entire purchase price of the car, which can save you a significant amount of money.
Why do leases have mileage limits?
A car’s value is based on its age and mileage, as the mileage determines how much the car has been used. Most leases have a mileage cap (usually 10,000 to 15,000 miles per year), and charge a per-mile fee for overage. (The mileage is cumulative; if you have a 2-year lease with 12,000 miles per year, it’s okay to put 15,000 miles on the car the first year, so long as you don’t put more than 9,000 miles on in the second year.) Always ask about the mileage limit when leasing a car. If it isn’t enough, you can usually get a higher limit for a correspondingly higher payment.
If I lease a car, do I have to pay to fix it?
In most cases, yes. You are responsible for maintenance, repairs (including collision damage), insurance, and replacing wear items (brakes, tires, clutches), just as if you bought the car. Lessees are also covered by the vehicle’s factory warranty and any aftermarket warranties you may choose to purchase.
What happens at the end of a lease?
At the end of a lease, the vehicle is returned to the leasing company (often, but not always, at the purchasing dealership). The lessee pays any fees that are due, including damage (see below), and the transaction is finished. (This differs for an open-end lease; see below.) Depending on the details of the lease, the lessee may have an option to buy the vehicle at terms specified in the lease agreement’s purchase option, or she may wish to turn in the vehicle and walk away.
Is it true that if you lease, you don’t actually own the car?
Yes, this is true — with a lease, you do not have equity in the car. However, this isn’t such a bad thing, as cars lose a tremendous amount of value over time, especially in the first couple of years after purchase. That said, not owning the car may appear to limit your flexibility. If you finance your purchase, you can keep it as long as you want, drive it as much as you like, and sell it whenever you want (though if you owe significantly more than the car is worth, this too may be prohibitively expensive). The time period of a lease is usually pretty airtight, and there are penalties for going over your mileage.
Why do some expensive cars have low lease payments while some inexpensive cars have high lease payments?
Leasing is based on the difference between the price of the car when new and the value of the car at the end of the lease. Therefore, a car that holds its value well may have lower lease payments (since the value at the end of the lease will be closer to the original price), while a car with poor residual value may have higher lease payments. Residual value is based on several factors, including the desirability of the car. Popular options (such as an automatic transmission) may actually lower the lease payments, since they increase the car’s desirability and residual value.
What are closed- and open-end leases?
In a closed-end lease, the residual value of the car is guaranteed by the leasing company. End-of-lease terms and costs are agreed to in advance and spelled out in the leasing agreement. An open-end lease is based on a predicted residual value; if the vehicle turns out to be worth less at the end of the lease, the lessee will be responsible for paying the difference. Most individual vehicle leases are closed-end leases. Open-end leases may offer lower payments, but they can carry some nasty surprises at the end of the term.
What costs and fees will I have to pay at the beginning and end of the lease?
There are several fees that will be collected at the beginning and end of the lease (see “Lease Terms Defined” for a detailed explanation of these fees). Some are negotiable, others are not. At the beginning of the lease you may see an acquisition fee, a documentation fee, a security deposit, registration and license fees, and a capital cost reduction (similar to a down payment). Some states also require sales tax to be paid up front. At the end of the lease, you may be asked for a disposition fee, and you will be charged for excess mileage and damage (see below). If you want to get out of your lease early, you will most likely be charged an early termination fee.
What is gap insurance (and do I need it)?
Gap insurance comes into play if the vehicle is wrecked or stolen before it is paid off. It covers the difference between what you owe on the car and what it is actually worth. Example: You finance a $30,000 car and crash it after three months. You still owe $29,000 on the car, but the value of the car has already dropped to $25,000, which is what the insurance company will pay (less your deductible). Gap insurance would pay the $4,000 difference between what the car is worth and what you owe, though it usually will not cover your deductible. Because lease payments are so low, and because the lessee is responsible for the cost of the car if it is damaged, lessees will almost always owe more than the car is worth. Therefore, gap insurance is a must-have for a lease; in many cases it is required and sometimes paid for by the leasing company.
Do I have to pay for damage at the end of the lease?
Damage affects the value of the vehicle, so the lessee is responsible for damage above and beyond reasonable wear-and-tear. Policies (and tolerance) vary from lease company to lease company, but many will ignore small scratches and dings. Large dents and scrapes, cracked glass, severely worn tires, unrepaired or poorly repaired collision damage, torn or burned upholstery, pet or smoke smells, badly scraped wheels, and mechanical problems are among the types of damage that may generate a bill. Most lease companies will allow you to have the vehicle inspected four to six weeks before the termination of the lease, which gives you time to explore repair options.
Who is the ideal candidate for a lease?
Leasing is ideal for people who like to get a new car on a regular basis. When you lease, you will be able to drive a late-model vehicle while laying out less cash than you would if you financed. Leasing can also allow you to drive a more expensive vehicle for a lower monthly payment. However, if you prefer to keep your cars for a long time (five years or more), or if you do not want to commit to keeping your vehicle for a set period of time, leasing may not be for you.