back to articles | December 31, 2018 | Dale Peterson

Categories: Leasing a Car

How Leasing Works

Leasing Basics

Don't be intimidated! For most people, leasing is an unfamiliar concept and therefore a little scary, but leasing isn't any more difficult than purchasing a car. Fully understanding how the leasing process works is the first step toward a positive leasing experience.

While many people haven't had experience with leasing a vehicle, most have rented a car at one time or another. Leasing a vehicle is similar to renting a car, just for a longer time period. Like renting a car, a person who leases pays a pre-determined rate to drive a vehicle for a pre-determined amount of time. You never own the vehicle and return it when your lease is up.

A person who leases enjoys the benefits of driving a car without assuming the up-front costs, and many of the risks of ownership.

Other leasing benefits include:

  • Easy on your budget! Monthly leasing payments are typically lower than monthly car payments.
  • Leasing often allows people to drive a more expensive car than they could afford if purchasing.
  • Brand new cars lose value as soon as they leave the lot.
  • Leasing helps avoid depreciation.
  • Leasing gives people a chance to drive a brand new car every few years.
  • Depending on your job, leasing a car may offer tax breaks not available when purchasing.

How Leasing Terms Work

Like purchasing a car, a car lease typically lasts for 24, 36, or 48 months; the longer the lease the lower the monthly payment. However, it's usually smarter to get a shorter lease. Your best bet is to get a lease for the same amount of time the car is under warranty. Doing so insures you are covered for most car problems for the entire time you are leasing the vehicle. Statistics show most cars begin experiencing problems after being driven for 4 years; therefore a lease term longer than 48 months should be carefully considered.

Let's Talk Money: How Leasing and Depreciation Work

Cars begin to lose value immediately after purchase and continue to lose value until they are scrapped. They become less desirable as they accumulate wear and tear or are replaced by newer models. This process is called depreciation. The cost of your lease depends on the expected depreciation of the vehicle you are leasing.

All cars have an expected depreciation schedule. In other words, before a car is leased for the first time, a dealer knows the vehicle's value, given normal wear and tear, for each year after it leaves the lot. When leasing, the difference between a car's original value and its value when the lease term is over, determines how much will be paid during the lease. That's the great thing about a lease; you only pay for how much the car depreciates as you drive it and aren't responsible for the remaining payments on a car that's continually losing value.

When leasing a car, you should have a clear understanding of the vehicle's depreciation schedule. Some cars lose value faster than others. For example, Volkswagen, Mercedes and Hondas are usually bring better lease rates than many American brands because they are known to have low depreciation.

Two cars can have the same initial price of $20,000 dollars, but after the lease ends their residual values can be very different. A car with a low depreciation expectation can be worth $15,000 dollars while a car with higher depreciation could be worth $13,000 dollars less. Before leasing make sure you understand both the car's original value and its projected value at lease end, called the residual value.

Determining Total Lease Costs and Payments

  • Know the new price value of the vehicle you want to lease.
  • Look up the vehicle's expected depreciation schedule.
  • Plan to lease the vehicle only as long as it's under warranty.
  • After deciding your lease term, find out the vehicle's expected residual value at lease end.
  • Find out the vehicle's Manufacturer's Suggested Retail Price – Don't pay this price!
  • The lease price you and the leasing company agree to is called the capitalized cost. Negotiate this rate as much as possible.
  • This price is always negotiable; at a minimum, it should be significantly less than the MSRP.
  • Look for ways to lower your capitalized cost in order to lower your monthly payments. First make sure you understand what fees are included in the capitalized cost. Then, ask about rebates, factory to dealer incentives and trade in values for your current vehicle.
  • When purchasing a car one of the factors to consider is called the interest rate. The equivalent to the interest rate when leasing is called the money factor. A good rule of thumb for determining a good money factor is to make sure it is equal or less than a typical new car loan interest rate if you were purchasing the vehicle.
  • Negotiate, compare and estimate. Come prepared with knowledge when leasing to get the best possible price.