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Guide to How Leasing a Car Works

How Does Leasing a Car Work? Car Leasing Basics
Kelly Boyer Sagert
Kelly Boyer SagertUpdated November 15, 2022
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
If you’re thinking about leasing a vehicle for the first time, it’s natural to wonder how leasing a car works. In this article, we’ll describe the leasing process, step by step, along with its pros and cons so you can decide whether it makes sense for you.

How Does Leasing a Car Work?

Leasing a vehicle resembles renting it for a predetermined time period, usually two to four years. You can typically negotiate and finance a lease through a dealership. Typically you’d pay a fairly small amount in taxes and fees to drive the vehicle off the lot. Then, you’d make monthly payments during the lease’s term. This may seem similar to car payments that you make when you buy a vehicle with auto loan financing, but when you lease, you’re not building any equity or ownership. Plus, there are typically annual mileage restrictions, and you’ll need to turn the vehicle back into the dealer in excellent shape to avoid paying additional fees.

Leasing vs Buying

Leasing is a form of financing that gives you the privilege to drive a vehicle for a set amount of time, whereas buying a vehicle gives you ownership of the vehicle.When you’re buying, you can either pay cash for a vehicle outright or take out a loan. If you’re getting a loan, it’s common to make a down payment with cash or by trading in another vehicle. Each month, you then make an auto loan payment. Car loans may charge car loan interest, although some lenders offer interest-free car loans with the annual percentage rate or APR fixed at 0%. Car loan payments go toward principal and any interest charges and fees that may apply. As the principal gets paid down, the loan amount goes down. When the loan is paid off, you fully own the vehicle. (It may be helpful to learn more about car loan amortization.) A lease is more like a long-term rental. You make a monthly payment in exchange for the ability to drive that vehicle during the agreed-upon term. When the lease term is up, you either need to return the vehicle or, if the lease permits it and you’d like to do so, you can buy it. How does leasing a car work? The below table highlights the differences between buying vs leasing a car:
Leasing a CarBuying a Car
You pay for the privilege to drive the vehicleYou own the vehicle and may hold the title
You have no ownership or equity in the vehicleYou own the vehicle with 100% equity if you buy the vehicle outright, or you can pay off a car loan to get full equity
You may face mileage allowance penalties if you operate the vehicle beyond the terms and conditions of your leasing contractYou have no annual limit on how many miles you can drive the vehicle

Car Leasing Terms to Know

Before you can understand car leasing basics, there are a few terms that are important to understand:
  • Acquisition fee: An upfront fee charged to the lessee for setting up the lease, typically ranging from $395 to $895. It can often be rolled into the monthly payment
  • Buyout price: The cost of the vehicle if you want to buy it at the lease’s end
  • Capitalized cost (cap cost) reduction: Rebates, trade-ins, down payments, and anything else that decreases the amount financed in the car lease agreement
  • Closed-end lease: A lease agreement that doesn’t require you to buy the car at the end of the lease or to pay the difference between the market and residual value
  • Depreciation: A decrease in the vehicle’s resale value due to operational usage, maintenance problems, aging parts, or other factors
  • Disposition fee: A fee charged by the lessor to clean and prepare the leased vehicle for resale after turned back in
  • Gross capitalized cost: Comparable to the vehicle’s selling price and sometimes called its “market value”
  • Lessee: The person who leases the car
  • Lessor: The dealership or finance company that leases the car
  • Mileage allowance: The number of miles the lessee can drive annually without penalty
  • Mileage fee or charge: The fee, typically assessed per mile, charged when the mileage allowance is exceeded
  • Money factor: Comparable to an interest rate, it’s a figure that lessors use to calculate monthly payments
  • MSRP: The manufacturer’s suggested retail price aka MSRP is the window sticker price or base price of the vehicle as recommended by the automaker
  • Residual value: The projected value of the vehicle at the end of the lease
If you don’t understand a term in your auto lease agreement, ask for help and/or do research to make sure you understand what you’re agreeing to. Recommended: Car Loan Terminology

Pros and Cons of Leasing a Car

When does leasing a car make sense? Like every financial transaction, leasing a car involves both pros and cons as detailed in the table below:
Pros of Leasing a CarCons of Leasing a Car
Lower monthly paymentsYou don’t own the vehicle
Less money required upfront to clinch the dealPayments don’t build equity
Fewer repair costsAnnual mileage restrictions apply
No responsibility for selling the carCar insurance premiums can be relatively high

Pros of Leasing a Car

Does leasing a car build credit? Yes, leasing a car can help you build credit while giving you access to a vehicle. People who decide to lease a car typically appreciate the lower monthly payments, as well as the upfront costs that are usually less than you’d pay with an outright purchase. Does leasing a car make sense? Signing a car lease may be right for you if you need access to a car at an affordable price. Also, the manufacturer’s warranty may cover certain mechanical repair costs. When the lease is up (and the vehicle may need repairs more often), you can turn in the car without worrying about finding a buyer and lease another new car. Or, if you like the vehicle and want to keep it, many short-term car leases allow you to buy the car at the lease’s end.

Cons of Leasing a Car

Just as renting a home doesn’t allow you to build up equity in the property, when you lease a car, you don’t own it. At the end of the lease, you have zero equity in the car. Even if you have the option of extending a lease, you’ll still have 0% equity when the extended term ends. Most leases have mileage restrictions, usually between 10,000 and 15,000 miles each year. If you exceed the annual limit, there’s usually a per-mile surcharge. You’ll need to pay for three types of auto insurance: comprehensive, collision, and gap. And, when your lease expires, you have no vehicle and likely will either need to buy that one or look for a different one to buy or lease.

Can You Lease a Car With Bad Credit?

Consumers with bad credit can lease a vehicle. For example, subprime and deep subprime consumers with low credit scores at or below 600 represented 4.18% of the consumers who leased new vehicles in the second quarter of 2022, according to Experian’s State of the Automotive Finance Market presentation for that quarter. The vast majority of consumers who leased new vehicles in Q2 2022 had good or excellent credit scores ranging between 661 to 850, but a minority of consumers with poor credit scores successfully signed new car leases that quarter. This proves you can lease a car with bad credit, but your monthly lease payment may be higher than lessees with excellent credit. Using Experian data, the below table highlights how good credit or bad credit may influence your monthly car lease payment:
Credit riskCredit scoreAverage lease payment for new cars
Super prime781–850$517 per month
Prime661–780$549 per month
Near prime601–660$561 per month

What to Know When Leasing a Car With Bad Credit

Here are some factors to know when leasing a car with bad credit:

High Cost of Financing

Consumers with bad credit could face steep fees when leasing a vehicle. Dealers might demand a bigger security deposit or down payment. The cost of leasing also includes the “money factor” or “lease factor” that determines your rent charge, which serves as the cost of financing. Leasing a vehicle may include a high cost of financing for consumers with bad credit. Part of your financing costs to lease a vehicle may include a car lease acquisition fee, which is the administrative fee leasing companies may charge to process your car lease application.

“Lease Here, Pay Here” Dealerships

“Lease here, pay here” (LHPH) car dealerships may offer leases to consumers with bad credit scores. Some of these dealerships, however, may impose high leasing costs and provide minimal repair coverage on the vehicle. You could also face some difficulties getting out of a car lease if the dealer does not allow early lease termination.

Where Can I Lease a Car With Bad Credit?

LHPH car dealerships and some leasing companies may lease vehicles to consumers with bad credit. Car dealerships often work with leasing companies, and some leasing companies have deep experience offering short-term leases to subprime and deep subprime consumers. Finding a leasing company that accommodates subprime consumers can be challenging, so you may have to network and shop around to find those companies.

Is It Easier to Lease a Car With Bad Credit?

No, it is much harder — not easier — to lease a car with bad credit because leasing companies are more likely to deny subprime applicants compared with auto loan lenders. Experian’s data, for example, show consumers with credit scores between 300 and 600 represented 5.46% of the consumers who financed new vehicles with auto loans in Q2 2022 but only 4.18% of the consumers who leased new vehicles that quarter. If you have bad credit and need access to a car, you might have an easier time getting approved for an auto loan than getting approved for an auto lease. The vast majority of consumers finance their new or used vehicles with auto loans, not leases. Data also show that car lessees, on average, have higher credit scores than consumers who finance their vehicles with an auto loan.

Tips for Improving Your Lease Approval Chances 

Here are some tips for improving your lease approval chances:

Get a Cosigner

A cosigner can help consumers with poor credit qualify for a car lease. The main applicant and cosigner share the responsibility of making regular lease payments during the life of the lease contract. Getting a cosigner with good credit can bolster your chances of getting your leasing application approved by a dealership or leasing company.

Down Payment

Making a down payment on the lease can help reduce your monthly lease payment to a more affordable level, which in turn may increase your chances of getting approved for a car lease. Dealerships or leasing companies may refer to your down payment as a capitalized cost reduction, which reduces your monthly lease payments by allowing you to finance a portion of the monthly lease payments in one lump sum up front.

Lower Your Debt-to-Income Ratio

Consumers with bad credit may increase their chances of getting a car lease by lowering their debt-to-income or DTI ratios. The dealership or leasing company may calculate your debt-to-income ratio to assess your ability to make monthly lease payments. If you have bad credit and a debt-to-income ratio below 36%, a leasing company may be more likely to offer a leasing contract than if your DTI ratio is above 36%. If you have a high DTI, reducing your outstanding debt balances could also help improve your credit score.

Alternatives to Leasing a Car With Bad Credit

Here are some alternatives to leasing a car with bad credit:

Lease Transfers

Sometimes car lessees may want to get out of their lease contracts, which can give you the opportunity to take over their lease through a lease transfer. You would assume the remaining lease payments if you take over someone’s lease through a lease transfer.

Car-Sharing Services

Car sharing can serve as an alternative to leasing a vehicle. A peer-to-peer (P2P) car-sharing service can allow you to rent a vehicle from a private owner to meet your short-term driving needs. You can choose the vehicle you want, wait for it to arrive at your home, and use it for personal purposes before returning it.

Financing a Car Purchase

As mentioned earlier, consumers with bad credit may qualify for auto loan financing. Auto loans generally feature higher monthly payments than car leases on average, but you can build an equity stake in the vehicle by financing the purchase with an auto loan. A leasing contract gives you 0% equity in the vehicle, whereas auto loans may give you a path to building 100% equity over time. There are at least 10 types of car loans that can help you finance the purchase of a car.

Saving Up to Purchase a Car Outright

Saving up to buy a vehicle outright may be an alternative to leasing a vehicle. One of the advantages of buying the car outright is it gives the buyer 100% equity in the vehicle from the start and the certificate of title. You can purchase a car as described in your buyer’s order without having to sign a retail installment sales contract.

How to Lease a Car in 9 Steps

How does leasing a vehicle work? Here’s how to lease a vehicle in nine steps:
  1. Check your credit score
  2. Set your budget
  3. Calculate what mileage you need
  4. Choose a make and model
  5. Test drive the vehicle
  6. Look for leasing deals
  7. Compare lease offers from different dealers
  8. Negotiate a vehicle lease
  9. Sign the paperwork
Here are more details about each step:

1. Checking Your Credit Score

When you apply to lease a car, dealerships will check your credit scores. In general, a FICO® score of at least 700 is preferable and can help the lessee get a lower monthly payment. If your credit score is less than desirable, options you might consider include a lease on a used vehicle, which may have guidelines that are less strict. Another option could be to focus on strengthening your credit history for a while before leasing.

2. Setting Your Budget

In general, financial and accounting professionals recommend that you spend somewhere between 10% and 15% of your after-tax income on car expenses, which would include the lease payment, car insurance, and gas. What’s most important is to calculate what you can afford and then stick to that dollar amount. 

Trading in a Car for a Lease

If you’re trading in your current vehicle to obtain the lease, the dealer will offer you a dollar amount for it. When there’s an outstanding loan on the vehicle, they will often take care of the nuts and bolts of paying it off, subtract that from their trade-in offer, and then take that amount off the lease costs. This can streamline things for you because the dealer typically handles the paperwork for these multiple transactions. Plus, in many states, this can save you money on sales tax since the amount (in those states) is only charged on the lease price after the trade-in amount is deducted. This can even happen with upside down auto loans (when you owe more than the vehicle is worth), although they can be more complicated.  Trading in a car may not be right for you if you have negative equity in the vehicle. If you don’t want to be stuck with an upside down auto loan, you may consider the possibility of someone else taking over your auto loan. You could also explore paying off your car loan faster and getting out of the upside down scenario.

3. Calculating What Mileage You Need

Let’s say that you’re offered mileage options of 10,000, 12,000, and 15,000 for each year of the lease term. How can you pick the one that allows you to avoid overpaying? When it comes to mileage, the past might be a good predictor of the future — or can at least be a reasonable starting point. How many miles have you been driving to work and/or school each week? What about running typical errands? If you take a weekly estimate and multiply it by 52, that can give you a good baseline. It may also help to factor in any car trips or vacations you take during the course of a year. Add in that mileage, too, and look at the total and then round up to the next mileage option.

4. Choosing a Make and Model

You’ll want to lease a vehicle that meets your personal and professional needs. Someone who spends lots of time transporting kids to sporting events will, for example, need something different from someone who picks up potential clients from the airport. You may also want to consider which vehicles depreciate the most quickly. Choosing a make and model that’s right for you is an important part of the process.

5. Test Driving the Vehicle

Test driving the vehicle before signing any leasing contract is an essential step in the process. This can help you confirm whether the vehicle meets your expectations. You have no obligation to lease a vehicle if you test drive it and discover you don’t like how it operates.

6. Looking for Leasing Deals

It makes sense to contact multiple dealerships to see what deals they have for people who are leasing a vehicle. Read the fine print, including mileage allowances, fees charged, the money factor, whether the lease is open or closed, the residual value, and the other details of the contract. Make sure you understand the terms, and if you don’t, enlist help you can trust. 

7. Comparing Leasing Offers From Different Dealers

After gathering information from multiple dealerships, compare the different offers to see what deal might be best for you — and don’t be afraid to negotiate. For example, you can negotiate to get the capitalized cost, also known as the cap cost, as low as possible. But if you succeed in bargaining it down, watch to make sure the dealer doesn’t add on other fees or extend the lease period (which wouldn’t benefit you because it adds to the number of payments). You can also negotiate the mileage allowance, the fees, the residual value, and more. The dealer doesn’t have to agree with what you propose, but it can often be worthwhile to try.

8. Negotiating a Vehicle Lease

As mentioned above, negotiating lease terms can be worthwhile to try. Negotiating a vehicle lease may persuade a leasing company to give you better terms that are right for you. You can negotiate for a lower monthly payment, higher mileage allowance, or a lower buyout price, among other factors.

9. Signing the Paperwork

Finally, the red letter day arrives and it’s time to sign your car lease agreement. When you sign, make sure that you understand every element of the agreement and that it matches what you negotiated.

What Happens at the End of a Car Lease?

When the lease ends, you can turn in the vehicle, pay any fees (such as mileage charges, disposition fees, and any fees for vehicle damage) and be done with the deal. Or you can turn the car in and start the leasing process all over again with a different vehicle. Or, if your lease permits and you’d like to buy the car, you refinance it. The price will be listed in the auto lease agreement, and you can then shop around for the best lease buyout refinancing deal.

Ways to Reduce Your Monthly Car Payment Without Leasing

Here are some ways you may reduce a monthly car payment without leasing:

Refinancing Your Loan to a Longer Term

Refinancing your car loan for a longer term can reduce your monthly payment. The downside to a longer term is it may increase the amount of interest you pay over the life of the loan. If you’re in the subprime risk tier, refinancing an auto loan with bad credit may be an option for you. 

Refinancing Your Loan to a Lower Interest Rate

Refinancing your car loan for a lower interest rate may reduce your monthly payment. An auto loan refinance calculator can show you how lower interest rates may reduce your monthly payment.

Talking to Your Lender

Talking to your lender and requesting a lower monthly payment can open the door to possible loan modification negotiations. A lender, for example, may agree to a longer repayment term that lowers your monthly payment. A longer term can increase the amount of interest you pay over the life of the loan.

Find Personalized Auto Loan Refinancing Rates Today

Leasing a car is similar to renting it for a period of two to four years. If you decide to lease, it’s important to understand car lease terms as you navigate the nine key steps of the process. It’s also important to understand that leasing may require good credit and that leasing gives you no ownership of the vehicle.  Getting an auto loan with bad credit may be easier than getting a car lease with bad credit. If you have a car loan, auto refinancing may lower your monthly payment. If you’re burdened with car payment debt and would like to explore auto loan refinance options, Lantern by SoFi can help. Refinancing might be right for you if you can lock in a lower interest rate. Find and compare auto loan refinance options with Lantern.

Frequently Asked Questions

What are some times when leasing a car is a good idea?
Is leasing a car a waste of money?
Is leasing or financing a car better?
Photo credit: iStock/Prostock-Studio

About the Author

Kelly Boyer Sagert

Kelly Boyer Sagert

Kelly Boyer Sagert is an Emmy Award-nominated writer with decades of professional writing experience. As she was getting her writing career off the ground, she spent several years working at a savings and loan institution, working in the following departments: savings, loans, IRAs, and auditing. She has published thousands of pieces online and in print.
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