Leasing 101: 5 Questions and Answers About Leasing a New Car
You’ve probably seen the advertisements: Lease a new car today and drive away with no money down and only $99 per month! Sound too good to be true? It may or may not be; the only way to know for sure is to know what car leasing is and how it works.
Leasing is more complicated than a traditional car loan, but with a little research it’s easy to figure out the pros and cons, and decide whether leasing is right for you. Here are some of the most common questions people have about leasing a car.
What is a Car Lease?
Like a loan, a lease is a way to finance a new car by making monthly payments over a set period of time. The biggest difference between a loan and a lease is that, when the lease ends, you have the option of returning the car and simply walking away — without the hassle of having to sell it or trade it in on another car.
There are a number of advantages to leasing. It’s a great way to get a new car every few years and enjoy the benefits of the latest advancements in safety, luxury, and performance, as well as a new-car warranty. For another, a lease’s monthly payments are significantly lower than those of a loan.
There are potential downsides to a lease, as well. These include a limit on the number of miles you can drive the car per year and the responsibility of keeping the car in good condition. It can also be very expensive to terminate a lease early.
Why are Lease Payments Cheaper Than Traditional Financing?
One of the most appealing features of a car lease is that the monthly payments are lower than with a loan. The reason is simple: With the lease, you’re only paying for part of the value of the car — specifically, the amount you “use” during the lease term.
Considered this simplified example of a hypothetical $20,000 car either purchased with a four-year loan or leased for those same four years. If you buy the car, you’ll be paying the full $20,000, or roughly $420 per month for 48 months. If you lease the car, your monthly payments will be based on the difference between the selling price and the amount the car is worth at the end of 48 months, which is known as the residual value. Residual value is determined up front; for this example, let’s say it’s $10,000. So, the cost to lease this car is roughly $210 per month.
The downside to leasing is that you don’t usually build any equity. In this example, if you spend $20,000 to buy the car, after four years you’ll own a car worth $10,000. If you lease the car, after those same four years you’ll have spent $10,000 but will then have to return the car to the dealer or spend another $10,000 to buy it. (In the real world, the total cost of buying a car at the end of your lease is higher than simply buying it in the first place.)
Am I Responsible for Regular Maintenance?
A lease comes with certain obligations, including the requirement to maintain the car per the manufacturer’s recommendations.While you don’t need to have the recommended service performed at a dealer, many people do since some manufacturers offer free scheduled maintenance, and you’ll need to go to the dealer anyway for recall or warranty repairs. Whatever you choose, make sure you keep all receipts so you can prove the car has been maintained properly.
What Happens if I Go Over My Mileage Limit?
This is one of the most common concerns with a car lease. A typical lease allows for 10,000 to 12,000 miles per year. If you go over that amount, you will be charged for the extra mileage, which can cost $0.10 to $0.25 (or more) per mile.
If you know up front that you’ll be driving more miles than the lease allows, be sure to structure the lease to include the extra mileage. Your monthly payment will go up, of course, but it will be less expensive than paying for the miles when the lease ends.
For those people who drive their car significantly more than 15,000 or 20,000 miles per year, leasing might not be the best choice. It all comes down to how much the additional miles cost and how much residual value the car loses as a result of the high mileage. At some point, when the residual value gets low enough, a loan will make more financial sense.
If I Like the Car, Can I Buy It at the End of the Lease?
Yes! When the lease ends, you have the freedom to choose what to do with the car: Return it, trade it in, or buy it outright.
You’ll want to carefully consider this course of action, however. For one thing, you’ll end up paying more in the long term than if you had purchased the car in the first place. In addition, it’s worth researching how much similar cars are currently selling for. While it can be worth a modest premium to buy “your” car, you might find an identical car selling for thousands of dollars less. If so, you might consider returning your car, buying that one, and enjoying the savings.
It’s also possible, depending on the market value of the car at the end of the lease, that the car is worth more than it would cost you to buy it. If this is the case, you can purchase the car and sell it yourself for a profit. Alternately, you can trade in the car and put that positive equity toward another lease.
Finally, it’s probably not a good idea to buy the car just to avoid paying for excess mileage or excessive wear and tear. While you might face a significant bill in the short term, you’ll likely end up paying more in the long run due to the car’s lower value, as well as the higher costs associated with buying a leased car.
While leasing isn’t the right choice for everyone, in the right situation it can offer a number of advantages over a loan, particularly those lower monthly payments. Now that you have a better understanding of how leases work, you can figure out the best way to finance your next new car.