A "car lease" is an arrangement in which you pay for the right to drive a new car. Basically, you (the lessee) pay money to the car’s owner (the lessor) for the right to keep the car for an extended period. When the lease period ends, you have to return the vehicle to the lessor. However, some leases allow you to buy the vehicle when the lease ends.
Much like renting a home versus buying one, leasing a car instead of buying it has its upsides and downsides.
How Does a Car Lease Work?
Car leases typically last two or three years. During this time, you may drive the car for up to a set number of miles, typically between 12,000 and 15,000 miles per year.
When you return the car to the lessor at the end of your lease, the owner will be left with a used car, whose value will be less than what it was when new. The lessor will set your lease payments to make up for that depreciation.
Example. Let's say you lease a car that costs $40,000 when new. The lessor assumes you will drive it to the maximum amount each year (12,000 miles) of your three-year lease. The lessor also knows that this car, with 36,000 miles on the odometer, will be worth 60% of its original value, or $40,000 x .6 ($24,000). In other words, it will have depreciated $16,000. The lessor will set the monthly payments so that, in sum, they’ll total $16,000 (the lessee will also pay various fees and taxes).
Upsides to Leasing a Car
Car leasing offers some advantages. Monthly lease payments are usually considerably lower than car loan payments. With lower payments, you can get a more expensive, better-equipped car and get a new one every few years.
Other advantages to leasing include:
- You typically have lower repair costs with a leased car because you’re covered under the vehicle's included factory warranty. In most cases, the vehicle warranty will last at least as long as the lease.
- At the end of the lease period, you take the car back to the dealership and either lease a new car or walk away. You don’t have to sell the car to a new owner or trade it in at the dealership.
Downsides to Leasing a Car
While leasing a car has several upsides, it also has drawbacks. For example, because you don’t own the car, you can’t do whatever you want with it. You can't permanently personalize or modify the vehicle. So, you can't add a spoiler or other permanent decorations.
Also, if you return the car at the end of the lease in anything less than good condition, you’ll have to pay a fee.
Other downsides to leasing include:
- When your lease period ends, you don’t own the car and have no equity. You'll end up paying more in the long run by leasing cars than if you bought a car and kept it for years.
- If you exceed the mileage limit, you’ll have to pay extra. This penalty generally ranges from 15 cents to 25 cents for every additional mile.
- The upfront leasing costs, including taxes and fees, can be as high as a few thousand dollars.
- If you want to get out of the lease early, you’ll have to pay an early termination fee, plus the remaining payments, and probably several other penalties and costs associated with getting rid of the car, like the costs of preparing the vehicle for sale.