Car Lease Basics and How Car Leasing Works

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Car Lease Basics

Car leasing is extremely popular because it offers a more affordable method of auto financing. It allows you to make lower monthly payments than with traditional loans. About one out of every five vehicles driven by automotive consumers in the United States are leased.

But leasing is not for everyone. You should take the time to learn about leasing, and be sure it's right for you before making a decision.

What is Leasing

Where a purchase loan is a method of financing the ownership of a vehicle, leasing is financing the use of a vehicle for a specified number of months, similar to renting but not quite the same thing.

A lease is a formal contract with a leasing provider that allows you to drive the provider's car and only pay for the portion of the vehicle's value that you use up during the time you're driving it. You agree to pay for insurance, licenses, taxes, repairs, and maintenance.

Leasing is not the same as renting; it's a method of financing the use of a vehicle over two or more years, with specific mileage limits.

The leasing provider retains ownership and title to the vehicle throughout the lease. At lease-end you can simply return your vehicle to the provider, or you may purchase the vehicle and continue driving it.

Benefits of Car Lease

A car lease offers the following benefits when compared to purchase loans:

- Lower monthly payments
- More car, more often
- Minimum or no down payment
- Smaller sales tax bite in most states
- No used-car headaches at end

Who Provides Leases

Contrary to popular belief, car dealers do not lease cars. Banks, credit unions, and financial divisions of major car manufacturers lease cars. Dealers simply act as agents of a leasing provider, such as Ford Motor Credit or GMAC, to arrange the lease on a customer's behalf. Dealers typically work with more than one provider.

Once you've picked out the car you want, the dealer sells it to the leasing provider, who leases it you. It's not necessary, nor is it always the best choice, to use the "captive" leasing company chosen for you by the dealer.

Dealers don't finance car loans or leases; they arrange financing on behalf of the customer, as a service.

You can arrange for your own car lease financing with an independent leasing company, bank, or credit union after you've negotiated a price with your dealer. Some lease providers even help you acquire vehicles at reduced prices, saving you money and the stress of negotiation.

Who Should Lease

Car leasing makes sense for many people, but not for others. Here's how to determine if you are a good leasing candidate:

• Are you willing to trade ownership of your vehicle for lower monthly payments? Leasing is a great way to lower your payments or drive a better car for your money, but you must be comfortable with having no ownership of your vehicle, unless you purchase at lease-end.

• Can you stick with your lease until the end? Leases require you to commit to driving your vehicle for a specific number of months — typically 24, 36, 48, or 60 months. If you feel your lifestyle, your finances, or simply your taste in cars may change significantly in future months, you may not be a good lease candidate. To end a lease early is usually troublesome and costly.

• Do you drive more than 15,000 miles annually? If your answer is yes, you may not be a good candidate because lease contracts are typically written with an annual mileage limit, typically 10,000-15,000 miles. If you drive more that the specified number of miles you will pay a fee for every mile over the limit.

Happy car leasers enjoy lower monthly payments, have a good credit rating, drive no more than 15,000 miles a year, keep their vehicles in good shape, and are capable of sticking with their leases until the end.

• Do you typically keep your vehicles in good condition and change vehicles every few years? If so, you may be right for leasing. Car lease providers require you to keep their vehicle maintained and repaired, with no more than normal wear and tear. If you don't, you'll be charged at the end of your lease.

• How is your credit rating? If you have a history of paying your bills on time and don't have excessive debt, you are a good lease candidate. Otherwise, you may be required to make a large down payment and pay higher finance charges or, worse, be refused the opportunity to lease.

Shopping for a Car Lease

The most important element of a good car lease deal is the price of the vehicle. Regardless of whether you buy or lease, you should always get the best possible price first. When leasing, this price becomes the capital cost, or "cap cost." Prior loan balances and fees may be added. Rebates, discounts, down payments, and trade-in credit are subtracted. The lower the capital cost, the lower your monthly payment. This is the only element of a lease deal that a dealer directly controls.

The remaining elements of a lease — money factor, residual value, and related fees — are controlled by the lease provider.

Since a lease is simply another form of car financing, interest charges apply. These interest charges are known as money factor. Money factor is expressed as a very small number such as .00375, which is equivalent to 9% annual interest rate. Again, a small money factor results in lower monthly lease payments.

A good lease means getting a good price on a vehicle that will not quickly depreciate in value.

Residual value is an estimate of a vehicle's wholesale value at the end of a lease term. The longer the lease, the smaller the residual value. Your lease payment is primarily determined by the difference between cap cost and residual value, which is the amount that the value of the vehicle depreciates during the lease. Finance charges and sales tax will also be included in your monthly payment.

When you get lease offers from a dealer, you should be able to use a lease calculator to verify the accuracy of the dealer's figures.

Leasing Fees

There may be certain fees associated with your lease. The fees that lease providers charge vary both in kind and amount. One of the most common is an acquisition fee, which is an administrative charge for the work in initiating a lease. Another common fee is a disposition fee, usually charged at the end of your lease when you return your vehicle.

At the beginning of your lease, you will be asked to pay the first month's payment, a security deposit, your down payment, if any, and applicable miscellaneous fees associated with licensing a vehicle in your state. You will also be asked to show proof of insurance.

For a complete guide to car leasing, go to the Lease Guide.

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