When you lease, you are paying for the use of a vehicle. Your payments cover
the cost of the vehicle's depreciation over the time you drive it, rather
than the purchase price. When the lease is up - typically in two to four
years -- you must return the vehicle or purchase it outright. This article
will explain what you need to know if you're considering a lease. Before you
make your final financing decision, you should also review our articles on loans and the differences between loans and
How lease payments are calculated
To calculate a lease payment, the
financial institution (the "lessor") estimates the amount the
vehicle will depreciate over the lease period, adds the interest being paid
by the lessor to finance the car while you drive it and several other fees.
Many leases can be started with 'no money down,' although a down payment
ensures lower monthly payments.
The Federal Reserve Board recently enacted
consumer-friendly legislation that requires dealers to disclose all the key
variables of a lease: the interest rate, residual value, length of lease, and
size of down payment.
The two- to three-year lease
Short term leases work for those who want a brand-new vehicle every few years. The manufacturer covers major
maintenance costs for the duration, and you usually pay for required
servicing. A major concern: if you terminate this type of lease early, you'll
most likely pay severe penalties.
Returning the car when the lease is up
When a lease expires, you can
either buy it, or return it. If you return it you must do the following:
- Return the vehicle in
its original state with no accessories, modifications, or different
- Make sure the vehicle
is in good shape, with no excessive "wear and tear." There are
penalties for damage or rough treatment.
- Meet mileage limits,
usually around 12,000 - 15,000 miles. You will be charged anywhere from
10 to 15 cents for every mile you drive over the limit, which can really
add up. For example, if you drive 20,000 miles per year for three years
on a 12,000 mile/15 cent lease, your penalty would be $3,650.
Opting to buy at lease-end
If you opt to buy at lease-end,
the key factor is the residual value of the vehicle or, in other words, what
the car is worth at that point. Most leases are "closed-end"
leases, which means that residual value is clearly stated at the start of
your lease. In most leases, you will pay this amount regardless if the market
value is higher or lower at the lease end. An "open end" lease
makes the consumer responsible for the potential gap between the residual
value and actual market value at the end of lease. This is a bigger risk than
a closed-end lease. It is rare this type of lease works for the consumer.
Key features of leases
The primary features of leases are
summarized below. Make sure you contrast these to the advantages of loans
before deciding on how to financing your vehicle. Check out Understanding Loans and Loan versus Lease
- Affordability: An
affordable way to drive a new car (and an upscale one that may be beyond
your purchasing power). Leasing payments (per month) are generally lower
than financing payments.
- Maintenance: Requires
you to maintain your car regularly, basically keeping it the way it left
the showroom. No customizing or altering the vehicle.
- Variety: A good option
if driving a new car is more important to you than owning one. A
reasonable and cost-effective alternative to buying every two years.
- Business benefit:
There are legitimate business reasons for leasing. You may be able to
deduct lease payments from your taxes.
- Mileage: Leasing
contracts have annual mileage limits, and the penalties can be
significant. If you plan on driving less than 12,000-15,000 miles per
year, you should have no problem with the mileage restriction.
- No down payment,
shorter payment schedule: Leases can often be initiated without any down
payment, and a typical two- to three-year lease lasts about half the
time of a typical auto loan.
- Penalties: Can mean significant penalties if you end your lease earlier than you initially
agreed. When you sign the contract, you have to keep it for the term
specified. Penalties differ from lease to lease.
- Constant payments:
Chances are, at lease-end you'll lease again and sign up for a new
- Warranty: Leased
vehicles are almost always covered by a factory warranty for the
duration of your lease contract. Major maintenance is not your financial
If leasing seems like a reasonable option for you, read
Leasing Tips before you