Car Leases: What To Know Before, During And After Leasing

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Car leasing is a popular alternative to buying a car, especially for people who don’t want to commit to a long-term loan. The lease itself is a contract that allows you to drive a new car for a predetermined amount of time, after which you’ll return it to the leasing company or dealership. The contract stipulates that you’ll make periodic payments on the car until the lease ends, and you won’t own it at the end of the term.

However, lease agreements are frequently full of specific jargon that first-time lessees may not be comfortable with. Being familiar with the fees, car lease terms and the common restrictions of a lease agreement can help you determine if leasing a car is right for you.

What is a car lease?

A car lease is a contract that allows you to drive a new car for a set period — typically three years — after which you return it to the dealership. Like an auto loan, payments are made on a monthly basis. When the lease ends, you can choose to turn it in or finance a lease buyout.

You will have limited mileage, and if you exceed the limit, you’ll owe extra fees. And like an auto loan, you will need to make a down payment when the contract starts and may be required to pay additional fees when the contract ends, including a disposition fee.

A lease allows you to rent a car long-term rather than buying it. But it comes with a handful of fees at the beginning and end of the contract. The first sections of your car lease contract will likely be focused on what you are expected to pay as part of the deal, including how the monthly payment is calculated. Then it will provide information about early termination, mileage limits, end-of-lease options and more.

How does leasing a car work?

Before you decide whether leasing is right for you, you’ll need to understand exactly how it works. There are steps you should take before, during and after leasing to make the process as headache free as possible.

Before the lease

A car lease agreement is a legal contract between you and the leasing company. In many cases, leasing a car is similar to renting an apartment. It lays out the terms and conditions of your lease, including the monthly costs, the length of the lease, restrictions, additional fees and more. Simply, the dealer or leasing company buys a car. You then agree to pay for your time using the car. 

Before signing on the dotted line, it’s smart to understand any potential penalties you could face. If you, for example, drive over the predetermined mileage limit, you’ll owe an excess mileage fee that can be expensive. You’ll also pay an excess wear-and-tear fee if the car has damage that exceeds what’s acceptable.

During the lease

During the lease, you’ll make regular payments to the leasing company. Since you’re not paying off the vehicle’s full price, your payments will be lower than if you bought the car and took out an auto loan.

Throughout your lease, keep in mind the restrictions that you may or may not have agreed to when signing it. Here are some common restrictions to be aware of: 

• Customization: Because the leased vehicle doesn’t belong to you, you are not allowed to make any customizations, such as adding a new stereo system or painting the vehicle.
• Early termination: If you are not sure whether leasing is right for you, you will be better off buying. If you terminate the lease early, you will be assessed a fee. The earlier you end the agreement, the more expensive it will be.
• Excessive wear: Your agreement will likely say that you must return the car at the end of the lease with no more than “normal” wear and tear. Read this section closely so you clearly understand the condition you must maintain for the car.
• Maintenance: The car you are leasing will need car maintenance during the period you are using it, and it might even need significant repairs. Make sure to read the section of your agreement that explains your responsibility for covering these costs.
• Mileage charges: Your agreement will stipulate a certain number of miles, usually 15,000 or less, that you are allowed to drive each year at no extra charge. It will also state the amount you will be charged per mile if you exceed this threshold.

After the lease

As you near the end of your lease term, you may start hearing from the dealership to find out how you want to proceed. Take your time to consider each option carefully and determine the right fit for you.

1. Trade it in: With this option, you are essentially replacing your lease that just ended with a new one for a different car. For those who love to upgrade every few years, this may be the most simple option.
2. Walk away: If you don’t want to lease a new vehicle right away, or you’d rather buy your next car, you can return the vehicle and simply walk away.
3. Buy the car: If you like the car you’ve been driving and want to purchase it, you can pursue this option. The purchase price will already be listed in your vehicle lease agreement, so you can shop around and compare prices to determine if it is a good fit for you. Some lenders offer specialized auto loans specifically for lease buyouts.

The pros and cons of leasing a car

Pros

• Lower monthly payments: Because you’re only paying for the use of the car during the lease period, rather than the full purchase price, you’ll usually get a lower monthly payment.
• Ability to upgrade: A lease typically lasts three years, meaning you can get a new car every few years.
• Repair coverage: If you lease a new car, it will likely still be covered by the manufacturer’s warranty.

Cons

• Mileage limits: You have to abide by a mileage restriction when leasing a car, and if you go over the limit, you’ll have to pay fees.
• No equity in the car: When the lease ends, you have to return the car and you won’t have any equity to use toward a down payment on another vehicle.
• Extra fees: If you turn in your car after the lease ends, you may face fees for wear and tear and for the dealer to prepare it for retail.

Common lease terms

Leasing jargon can be complicated; here are some common lease terms that you might run into when leasing a vehicle. 

• Acquisition fee
  

  An acquisition fee is the charge leasing companies assess to arrange the lease. It is generally not negotiable and costs between $595 and $1,095, according to Edmunds. You can also expect to pay a higher acquisition fee for cars with higher price tags and luxury vehicles.

• Amount due at signing
  

  The amount you will need to pay when you sign. It includes your down payment, but the agreement will also break down any fees, credits or rebates that factor into the total amount due. For example, trading in another vehicle will lower the amount due.

• Buyout price
  

  Look for the amount you may be able to purchase the vehicle for — along with any related fees — at the end of your lease period.

• Capitalized cost
  

  Also called cap cost, this is the vehicle’s selling price used to calculate depreciation and how much you owe.

• Capital cost reduction
  

  This includes any down payments, trade-ins and dealer rebates that lower the cost amount being financed.

• Disposition fee
  

  The disposition fee covers the costs the dealer incurs to prepare the car you leased for resale. Expect to pay between $300 and $400 to cover this charge, notes Edmunds. However, you can often have the fee waived if you sign up for a new lease of the same car brand or buy the car at the end of the lease.

• Early termination fee
  

  The agreement should explain any fees you will be charged if you need to get out of your lease early. Ending a lease early usually comes at a steep cost — and may require you to make all of your payments despite returning the vehicle.

• Excessive use
  

  Your lease will show you how many miles you are allowed to drive each year. You will be charged a fee based on the number of miles more than that limit you drive — sometimes up to 30 cents per additional mile. It may also reference damage to the vehicle that you will need to pay for when the lease is over.

• Money factor
  

  To find out what your interest rate is, multiply the money factor by 2,400. For example, a money factor of 0.0032 times 2,400 gives you an interest rate of 7.68 percent.

• Monthly payments
  

  The agreement should state the amount you will pay each month and include a detailed breakdown of the factors — including sales tax and estimated depreciation — that were used to determine that amount.

• Residual value
  

  This is the estimated value of the vehicle at the end of the lease due to depreciation. Cars that depreciate more slowly than others have a higher residual value and lower monthly payments.

Is a car lease like a loan?

Leases and loans are different. A car lease is a long-term rental, and you pay rent for the use of the car. A car loan is when you borrow money from a financial institution for a certain period, and then you own the car.

With a car loan, you’ll pay off the car over time and build equity in the vehicle. With a lease, you’re only paying for the privilege of driving the car for a set amount of time and miles. When the lease ends, you’ll either return the car to the dealership or buy out your lease if you decide to keep the car.

Regardless of whether you lease or buy, you will need to carry insurance. In fact, proof of insurance is typically required upon applying.

Bottom line

There are pros and cons to leasing, but if you have already decided that you want to lease instead of buy, it is important to understand the language in the lease agreement. Not only will it help you understand how your monthly payment is calculated, but it will also clarify your responsibilities while the lease agreement is intact — and possibly save you from incurring costly fees and penalties.