Lease or buy – before you make a decision that could impact your finances for years, ask yourself the question: how does leasing a car work? Many consumers are familiar with buying a car and financing it, but when it comes to leasing, they may be under a few misconceptions – that could prove costly. How does leasing a car work? Here’s a basic guide.

Leasing is a financial concept, a method of financing a car that is similar to a loan. It has become popular over the last decade to the point where about 25 percent of all new vehicles – cars, trucks, SUVs – are leased today. There are advantages to leasing, as well as drawbacks. The savvy consumer should learn as much as possible about leasing a car before choosing this option.

Price is Important

The first thing to keep in mind is that you need to negotiate a price with the dealer before arranging financing. Many consumers think that the sticker price is the lease price, but, just as you negotiate a purchase price with the dealer, you also need to negotiate one on a lease. The only exception is if the dealer is advertising a special lease deal where price and other lease factors are already taken into consideration.

When consumers buy a vehicle, they are paying for the vehicle’s negotiated price, plus financing and fees. In a lease, consumers only pay for the vehicle’s depreciated price (the estimated resale value at the end of the lease), plus finance charges and any fees. That’s why lease vehicles have substantially lower monthly payments than financed cars.

Who is the Leasing Company?

The lease is owned by a leasing company, not the dealer. The dealer acts as an agent for the leasing company. Once you sign the lease contract, your relationship is with the lease company, not the dealer (except for warranty and service items).

Dealers generally use leasing companies that are subsidiaries of the automaker, such as Ford Motor Credit (a subsidiary of Ford Motor Company), Ally (the finance arm of General Motors). But the dealer may also offer leases from banks and other institutions with whom they have an existing relationship. Consumers can also arrange leasing on their own through banks and credit unions.

Lease Details are Key

Consumers considering a lease need to know the following:

  • Regular payments – Just like a financed car loan, in leasing, the consumer is required to make regular monthly payments. Typically, lease terms are for 24, 36, or 48 months.
  • Return of vehicle at end of lease – At the end of the lease, the customer is expected to return the vehicle to the leasing company with no more than normal wear and tear. Each lease contract contains specific language regarding what is and is not permitted – or is provided as a separate document, often called the lease guide.
  • Options at lease end – Consumers may have the option to purchase the vehicle at the end of the lease for a specified price. Or it may be used as a trade-in on another lease or purchase. But be careful not to just give back to the dealer a car that you may have equity in.
  • Other factors – Leasing is a bit more complicated process than financing and involves other factors such as residuals, money factors, gap insurance, and more.

Leasing Advantages

If you’re looking at a luxury car and wondering how does leasing a car work, you’re in good company. In the luxury market, about 75 percent of cars are leased. But many top-of-the-line cars, SUVs, and trucks are also leased that aren’t luxury makes. Why is this? The chief advantage to leasing over financing is significantly lower monthly payments.

Another draw favoring leases is the ability to have a new car every two to three years with no major repairs. Some consumers just want peace of mind, a car that’s always covered under warranty, and a new car at a specified time without the hassle of selling the current one.

Leases often require little or no upfront payment, unlike a loan. And consumers pay less tax on a leased vehicle – because you’re only taxed on the portion of the vehicle value used during the lease.

Leasing Disadvantages

Leasing is not like renting a vehicle, although many consumers mistakenly consider it a rental. In renting a car, it’s typically for a few days, while a lease is at least 24 months, with stiff penalties for early termination (if it’s even allowed according to the lease terms).

The main difference is that at the end of the lease, the consumer doesn’t own the vehicle.

Buying at the end of the lease is always more expensive than purchasing it to begin with.

Lease vehicles always have a mileage cap, with a cents per mile charge for miles exceeding the cap. If consumers drive a lot, this can be tremendously expensive and is a big disadvantage to leasing.

Leases may require a security deposit upfront.

Summing Up

How does leasing a car work? Get all the details before you make a commitment. Leasing could be just right for you. On the other hand, you may be better off with a car loan. Weigh and balance all your options and then  make your best deal.

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