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Leasing a New Car

If you are thinking about leasing a car, you need to understand how car leases work. When you lease a car, you sign an agreement with a dealer that allows you to drive the car for a certain number of years. The rules and costs can be complicated, so it's a good idea to do your homework before you sign.

Lease terms

  • Adjusted capitalized cost. This is the sticker price minus any discounts, rebates, package savings, allowances and deductions from profit that the dealer is willing to make. It is the actual buying price, not the manufacturer's suggested retail price.
  • Residual value. This is the market price the vehicle is predicted to be worth at the end of the lease period. Most cars have a residual value of fifty to fifty-eight percent for a 36-month lease. A bank or a car dealer can tell you the residual value.

When negotiating a lease, it's worth it to try to bargain with the dealer about the adjusted capitalized cost; a lower "cap cost" will result in a lower lease payment. While residual value is typically not negotiable, it's a good idea to do your own research on the residual value of the vehicle you're interested in to be sure that your lease payment is based on accurate figures.

Interest costs

In addition to covering the lessor's depreciation loss on the vehicle, your lease payments will include interest and other charges. Different leasing companies will have different ways of expressing the cost to you of borrowing their money and will generally use one of these terms:

  • Money factor. Some leasing companies provide information about interest charges in the form of a "money factor." This is a tiny number (for example, .00375). If you multiply it by 2400, you get an approximate annual interest rate. For example, .00375 x 2400 = 9.048.
  • Lease charges. This is a dollar total that includes interest and some other charges. If the dealer quotes you $5,000 in lease charges on a forty-eight month lease, you need to ask how much of that is interest charges. If $4,400 is interest charges, you can divide that by the forty-eight months and see that you'll pay $91.67 per month in interest.

There are variations on these terms. This is one reason why you should go home and do your own calculations after talking to a dealer. Don't let anyone rush you into a decision, and don't rely on anyone else's calculations when comparing one lease deal with another.

Sales tax

The salesperson may not talk about sales tax. After all, he or she has no control over it and you can't negotiate it. But in most states it will become part of your monthly payment, so find out what it is and factor that in. In some states, like Texas and Illinois, you must pay the entire sales tax up-front. To find out how much you will pay each month in taxes on your lease, multiply the monthly lease payment by the state sales tax.

Gap insurance

You'll probably want gap insurance. If the leased vehicle is stolen or wrecked before the lease is up, you are still responsible for making the rest of the payments. Ordinary insurance won't cover that, but gap insurance will, and it usually isn't very expensive.

Up-front costs

When a lease is signed, there are several costs that may be due up-front, usually called "lease inception fees" or "drive out costs." These may include the following:

  • A security deposit that may be refunded to you at the lease's end, less any mileage, damage or other charges
  • Documentation, registration, license, tag and title fees
  • The first month's lease payment

Mileage charges

If you regularly drive more than the number of miles set by the leasing agency (usually 15,000 miles a year), at the end of the lease you will be charged for any extra mileage. These charges can add thousands of dollars to the total cost of a lease, so it's wise to compare the mileage deals different lessors are offering. It may be possible to buy extra mileage in advance at a better rate, or pay a higher monthly payment for more miles.

Monthly and total payments for sample twenty-four and thirty-six month leases

As with a car loan, a longer term means lower monthly payments. However, it's probably not wise to have a lease that outlasts the vehicle's general warranty. If you do, you can end up paying for expensive repairs on a car that you do not own and may never own.

The most common lease terms are 24 and 36 months. A 24-month lease may be right for you if you feel you may tire of the vehicle. But monthly payments are lower for a 36-month lease because the sharpest drop in car value occurs in the first two years. Spread out over three years, the loss in value averages out to be less per month. The following example illustrates the difference between a two and three-year lease.

24 months
36 months
Adjusted capitalized cost (new car value)
Residual value (predicted, at end of lease)
Monthly payment
Total paid out over life of lease

Some leases require you to pay a "cap cost reduction," which pays off some of the projected loss in value up-front, reducing the principal you must repay over the life of the loan and lowering your monthly payments. Whatever you pay up-front, and whatever the payment amounts, the lease payments are the same every month and are amortized like a mortgage.

The monthly payments are higher when you buy a car with a loan than they are when you lease. But when you purchase, you own the vehicle. After the loan term ends, you have no more monthly payments, but you will still have the vehicle.
Important considerations when leasing

  • Shop around from dealer to dealer comparing lease offers.
  • Negotiate the asking price for the vehicle down as far as you can, just as you would if you were buying a car. There are many available resources, including guides, websites and computer programs to help you determine the actual cost to the dealers.
  • Make sure that the lease states clearly what the residual value is. Manufacturer-subsidized leases may provide the best deals, since they may list a higher residual value for their own cars. They may offer lower interest rates as well.
  • Find out precisely what interest rate is being charged on the amount you are "borrowing" from the leasing agency.
  • Make sure you understand the mileage limits and penalties.
  • Be aware that you may be charged for excessive wear and tear. Follow the maintenance schedule as though you own the car.
  • Explore the possibilities for bailing out of the lease. At the least, you will have to pay the difference between the current value of the car and the principal you have already paid.
  • Just as in buying a new car, don't let yourself be rushed by an eager salesperson. Always give yourself time to go home, go over the calculations yourself, compare the various offers, and call back with questions or counteroffers.

Since your ability to lease a car will depend upon your credit rating, you may want to read about protections against credit discrimination through the Consumer Financial Protection Bureau. If your credit is in bad shape, and you're looking to rebuild it, check out the Repairing Your Credit podcast.


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