Auto lease how does it work

The two primary factors that determine how much you pay per month for your leased vehicle are its depreciation and your money factor. Like all cars, as you drive your leased vehicle it depreciates in value, meaning the price it could sell for on the open market decreases.

To account for this loss of value, your leasing company requires you to pay for the value it expects your leased car to lose as you drive it. When you negotiate your lease, you and your car leasing company agree on how much the car is worth at the beginning of the lease and your leased company estimates how much it will be worth at the end of your lease.

The graphic below illustrates the two values your leasing company uses to calculate the depreciation you pay for with your lease payments. A: The capitalized cost of your leased vehicle sometimes known as the Lease Price is the value of the vehicle at the beginning of your lease plus any additional fees that your lease issuer adds onto it. The capitalized cost of your lease is negotiable before your lease, and, like the purchase price of a car, you want to get the capitalized cost as low as possible, because doing so will help lower your monthly payments.

B: The residual value of your leased vehicle is what your leasing company expects the car to be worth at the end of your lease.

They calculate residual values based on historical data and on the number of miles they expect you to drive your vehicle, which is usually 12, to 15, miles per year.

Note, if you choose to buy your leased vehicle at the end of your lease, you often have the right to buy it at the residual value no matter what the car is actually worth on the open market at that time.

The important point to take away from this graphic is that much of your monthly lease payments go towards paying for the depreciation on your leased car. Consequently, the higher your lease company sets your Residual Value all other things equal , the lower your monthly payments will be. When the residual value is set high, how much you pay per month can be substantially less than you would pay if you had purchased the vehicle instead of leasing it.

For this reason, people sometimes lean towards car leasing over car buying because leasing often allows a person to get a car for lower monthly payments than he or she could by purchasing it.

Sometimes, people like to think of leasing as buying part of a car. Only, the part of the car you are buying is the piece that the leasing company expects will depreciate away before the end of the lease. These guidelines specify the types of damage you would have to pay for before you return your car. If the car is significantly damaged, drivers can expect to be charged full market prices for repairs.

Warranties vary from manufacturer to manufacturer, but they typically last up to three years or 36, miles, whichever comes first. If you keep the car for longer than the warranty period, you may have to consider an extended warranty. Choosing to lease instead of buying a car can be a great way to drive a newer car with the latest technology and features for less money per month.

But do your homework, shop around and pay close attention to the terms and conditions to make sure that you get a lease that fits your driving habits and your budget. How We Make Money. Dan Miller.

Written by. Dan Miller is a contributing writer for Bankrate. Dan writes about loans, home equity and debt management. Edited By Chelsea Wing. Edited by. Chelsea Wing. Chelsea has been with Bankrate since early She is invested in helping students navigate the high costs of college and breaking down the complexities of student loans. Share this page. Bankrate Logo Why you can trust Bankrate. Bankrate Logo Editorial Integrity. Key Principles We value your trust.

At the end of the lease, you'll return the vehicle and have to decide if you want to start a new lease, purchase a car or go carless. Read on for more on how a car lease works and whether it may be the right choice for you. A car lease is an agreement between a lessor the company that owns or will buy the car and the lessee the person who will pay to borrow the car. When you lease a vehicle, your monthly payment will be calculated based on the vehicle's depreciation—the change between its current value and its value at the end of the lease—plus interest and fees.

Some of the rules may seem restrictive, but remember, you don't own the vehicle. The lessor keeps the title, and you have to return the car in good condition at the end. As with taking out an auto loan, leasing may be easier and less expensive if you have good credit. The cars you're allowed to lease may be limited if you have bad credit. Higher scores might also help you qualify for a lower monthly payment. This is because your credit can impact your money factor, the financing charge portion of your monthly payment.

Some dealers offer leases on used vehicles , which may be easier to qualify for if you have bad credit. However, the lease may have high fees and lack many of the advantages that come with leasing a new car. For example, you may be responsible for all the repairs and maintenance during the lease. You might be better off trying to improve your credit and finances and then looking for a lease.

Or consider purchasing a used car that's a better match for your budget. The language in a car lease agreement may be new to you and can sometimes be confusing. Here are some of the common terms and their definitions:. Deciding between buying, leasing and waiting can be difficult, and you'll want to consider the pros and cons of each option. The difference between leasing and financing is that with financing you are purchasing the vehicle to own, and with a lease you usually don't own the vehicle.

Unless your contract has the option to purchase the car at the end of the contract period, you must turn it back over to the lessor. Drivers who prefer to lease instead of buy tend to do so for a couple of major reasons. First, they get to drive a newer vehicle that remains under warranty throughout the lease period and, therefore, rarely requires anything more than routine maintenance.

Second, monthly payments for a leased vehicle are normally smaller than those for a purchased vehicle. That's because lease payments are based on the depreciation in value of the vehicle over the course of the lease period instead of the vehicle's full value. As a result, drivers can lease a vehicle that is nicer and more expensive than one they could afford to purchase.

There are disadvantages to leases, too. One is that over the course of a lessee's lifetime, they will likely end up spending more on their vehicles than a buyer. Another disadvantage is that at the end of the lease period, the lessee must turn in the leased vehicle or buy it through a purchase option agreement and walk away without any equity in the vehicle.

So, which option is best? That depends on the driver's unique needs and preferences. Cost is always the bottom line, and when it comes to figuring the cost of a car lease, it can get a little complicated.

That's why it's important to have a good basic understanding of the terms used in the lease agreement. When you sit down with the dealer to go through the lease process, here are the most common terms you will have to deal with:.

This is the full price of the new vehicle, also known as the sticker price. Except for the rare case when a specific model is in high demand, you should be able to negotiate the MSRP down, sometimes significantly, because it's only a suggested price. This is the base price that you hopefully negotiated down to from the MSRP. The cap cost can also be referred to at this point as the "lease price. It's a good strategy not to let the dealer know that you intend to lease the vehicle until you have determined this cost.

And if your dealer tells you that you cannot negotiate the MSRP down if you plan to lease, don't believe it.