Leasing a vehicle can be an attractive option for drivers who want a brand new car with a low down payment and small monthly installments. Although a leaseholder (called a lessee) doesn't actually own the vehicle and will eventually have to return it, leasing is a bit more complicated than just a long-term car rental. A lot goes into securing a favorable lease, and understanding the variables is critical. If you don't do your homework, what was supposed to be a cheap alternative to owning can become a frustrating, expensive hardship for a car that isn't even yours.
Most new cars are covered by a bumper-to-bumper warranty for the first three years or 36,000 miles. Keep that in mind when negotiating the length of your lease. If something goes wrong with the car during the warranty period, it's covered -- fixing it won't cost you anything out of pocket. Stretching a lease beyond three years will reduce monthly payments, but lessees should understand the danger of the temptation. The short-term savings in lower payments could cost a lot more down the road if you have to put money into repairing a car that you don't own.
When negotiating a lease, be honest about your driving habits. Most contracts give the driver 12,000 miles a year. Therefore, under a common three-year lease, the lessee is charged for every mile driven over 36,000 miles, generally between 10 and 15 cents a mile. Drivers who know they won't stay within the 12,000-mile limit have the option to buy extra miles up front. This usually costs half -- or even a third -- of what it would cost to pay for the same amount of miles in overage charges when the lease is up.
Related: 11 Tips for Taking a Road Trip on the Cheap
Most outrageously good lease deals advertised on TV come with small print that disguises hidden fees. One of the most common costs is a drive-off fee, which is essentially a payment necessary to start the lease. Drive-off fees can be significant, and lessees shouldn't expect to negotiate down to much lower than about $1,000. Other hidden costs that are camouflaged in fine print are sales tax, shipping fees, and dealership fees.
When you've decided on the car, the number of years the lease will run, the number of miles likely to be driven, and any drive-off fees, remember that competition is good for the buyer. Instead of shopping in the conventional way, consider shopping through manufacturers' or dealers' websites. The strategy will result in lease quotes on the same vehicle from competing dealerships. When you find the lowest price, call around to other dealerships and give them an opportunity to beat the deal.
The term "money factor," sometimes called "lease factor," describes the amount paid each month in finance charges. Money factor is expressed as a miniscule number, which some people mistake for an outrageously low interest rate. It's not. The more common APR, or annual percentage rate, can be calculated by multiplying the money factor by 2,400. If the money factor is .002, the APR is 4.8 (.002 x 2,400). If the money factor is .00275, then the APR jumps to 6.6 percent. The lower the money factor, the lower the finance charge and, therefore, the monthly payment.
Depreciation is the difference between the value of the car when it's new at the dealership and its residual value at the end of the lease. The lessee pays for depreciation -- and some cars lose value faster and more dramatically than others. Two different cars may have the same sticker price when new, but the one that depreciates faster will cost more to lease. In short, avoid leasing cars that are known to depreciate quickly, including the Mini Cooper, Lincoln MKS, Volvo S80, GMC Yukon, and Chevrolet Impala. Instead, lease cars projected for three-year residual values of more than 50 percent of the original sticker.
When leasing a car, it's wise to negotiate price as though planning to buy it outright. Dealers sometimes imply or plainly state that they can't negotiate the sticker price for leases, but that's untrue. Lessees can and should negotiate the sticker price before negotiating the terms of the lease. The final sticker price -- plus any fees, add-ons, or taxes that will be financed instead of paid for with cash -- make up the car's capitalization price, or cap price. The lower the cap price, the lower the lease payment. Buy negotiating down the sticker price as if they were buying, lessees can lower the cap price and, in turn, the monthly payment.
Most lease contracts provide guaranteed auto protection, or gap insurance. If not, it's critical for lessees to buy their own. Gap insurance does exactly as the name implies: fills a gap in coverage left open by traditional auto insurance. If the car is stolen or totaled, traditional insurance covers only the current market value of the car, not the amount of money owed to the finance company. Because leases make small down payments and depreciation may outpace monthly installments, that can leave a gap in coverage of thousands of dollars -- a difference you could be stuck paying without gap insurance.
Lessees can be hit with a wide range of unforeseen expenses when returning the car as the contract expires. Virtually all lease contracts contain a clause regarding the condition of the car when it's returned, usually written in vague language. The lease permits "normal wear and tear," but the dealer will charge for "excessive wear," to help reduce the cost to refurbish a vehicle for the used-car market. Mechanical problems; scratches, dings, and dents; and tears or stains in the upholstery are just some of the things that may incur charges, should repairs be necessary.
Related: Tire Installation Costs Compared: 7 Chains Face Off
Once the contract is signed, the lease agreement is ironclad. A lessee who wants to exit the contract before the term is up can expect to be hit with significant early termination fees. Penalties can easily climb into the thousands and are often all due at once, meaning they can't be paid in monthly installments. Before signing, see if the contract allows for a lease transfer -- essentially selling the lease to another qualified buyer. Websites such as LeaseTrader.com and SwapLease.com pair drivers looking to exit leases with consumers seeking to buy into one.
Most contracts give the lessee the option to purchase the car at the end of the lease, or, in some cases, before the lease term expires. But whether that's a good idea or not is subjective. Lessees have already paid for the car's depreciation. Buy buying at the end, they're simply paying for the vehicle's residual value. That can be good for lessees whose financial situation has changed since they first leased, and who can now afford to buy the car outright. In other cases, the lessee may opt to buy because of excessive damage for which they don't want to be charged.