Leasing a car is effectively renting it for a fixed term—usually two to four years—rather than buying it outright. You pay a series of monthly fees in exchange for the right to drive the vehicle, and at the end of the lease you return it to the dealership (or sometimes buy it). Because you’re only paying for the car’s depreciation during the lease term, rather than its full purchase price, monthly payments tend to be lower than loan payments for buying the same model.
How Lease Payments Are Calculated
Each monthly lease payment is made up of three main parts:
- Depreciation
This is the difference between the car’s initial value (capitalized cost) and its estimated value at lease-end (residual value). You cover this loss in value over the term. - Finance Charge (Money Factor)
Similar to interest on a loan, the money factor is a decimal that’s multiplied by the sum of the capitalized cost and residual value to determine your financing cost. To convert a money factor to an APR, multiply it by 2,400. - Taxes and Fees
Depending on where you live, sales tax may be applied to each payment. You may also pay acquisition, disposition, registration, and documentation fees.
Putting it together, your monthly payment looks roughly like this:
(Capitalized cost – Residual value) ÷ Term
- (Capitalized cost + Residual value) × Money factor
- Taxes and fees
Key Terms in a Lease Agreement
- Capitalized Cost (Cap Cost): The negotiated price of the vehicle at lease signing.
- Residual Value: The projected value of the car at the end of the lease term. Higher residuals mean lower depreciation charges.
- Money Factor: The lease’s financing rate expressed as a small decimal.
- Mileage Allowance: The maximum miles you may drive per year (commonly 10,000–15,000). Excess miles are charged per mile at lease-end.
- Disposition Fee: Charged by some lessors to cover the cost of preparing the vehicle for resale.
Advantages of Leasing
Leasing can make sense if you:
- Prefer lower monthly payments.
- Like driving a new vehicle every few years.
- Want warranties to cover most repair costs.
- Like predictable budgeting without large down payments.
Considerations Before You Lease
- Mileage Limits: If you drive more than the allowance, excess-mileage charges (often $0.15–$0.30 per mile) can add up.
- Wear-and-Tear Standards: Most leases expect “normal” wear and charge for damages beyond that (e.g., deep scratches, torn upholstery).
- Early Termination Fees: Exiting a lease early can incur substantial penalties.
- Up-Front Costs: You may need to pay the first month’s payment, a security deposit, acquisition fee, and registration fees at signing.
Lease-End Options
At the end of your lease term you generally choose one of three paths:
- Return the Vehicle: Simply drop it off, pay any end-of-lease fees, and walk away.
- Buy Out the Lease: Pay the residual value (plus any purchase fees) to own the car.
- Lease a New Vehicle: Start a fresh lease, often rolling over any outstanding balance into the new deal.
Conclusion
Leasing a car can offer lower monthly payments, the enjoyment of a new vehicle every few years, and reduced maintenance worries. However, you should weigh mileage limits, potential end-of-lease fees, and your driving habits before deciding. Understanding the components of a lease payment—depreciation, money factor, and fees—will help you negotiate confidently and choose the option that best fits your budget and lifestyle.