The Smart Student's Guide to Leasing a Car

Car leasing may be a good idea if you want to drive a new car every two, three, or four years—and you don’t mind that you will always be making payments and never actually own the car. The monthly lease rate will typically be lower than the monthly car loan payment for the same new car. You pay for this savings in the following ways:

• You don't own it: At the end of the lease, you hand the car back to the leasing company. With a car payment, you eventually pay off the car and own the vehicle outright. To lease a car with an option to buy is almost always more expensive than buying a car outright, so if you intend to buy the car anyway, try to buy it upfront.

• Mileage limits: New car leases generally limit the number of miles you can drive the car to 10,000 to 15,000 miles per year. If you exceed your limit, you're slapped with “excess mileage” charges at the end of the lease. If you're thinking about leasing a car—but drive 1,000 miles to college every semester or take road trips—you need to think carefully if you will be able to stay within mileage limits.

• No get-out-of-lease-early-free card: The most common problem people have with car leases is that they need or want to end a lease early. Car lease contracts are purposely written to discourage early termination. If you terminate a car lease early, you are subject to paying termination charges and all the remaining payments.

Car leasing works best for those with a stable lifestyle and good job situation. The Federal Reserve Board Web site is a great source for lease information. Also check out www.LeaseGuide.com.

Buying vs. leasing

The upfront costs of buying a car are typically higher than for leasing. Here's why: When you buy a car, you typically make a down payment on the car, pay sales tax, and make monthly payments (including interest) on the amount of the purchase price you financed with a car loan. For example, if a car costs $20,000 and you pay a 7% local sales tax, your total cost is $21,400. If you made a $1,000 down payment, then your monthly car payment will be based on borrowing $20,400. You are paying for the entire cost of a vehicle regardless of how many miles you drive it or how many years you own it.

When you lease a car, you pay for only a portion of a vehicle's cost, which is the part that you "use up" during the time you're driving it. You have the option of not making a down payment, you pay sales tax only on your monthly payments (in most states), and you pay a financial rate, called money factor, that is similar to the interest rate on a loan. So, if you lease a $20,000 car on a 24-month lease, and that car will have an estimated resale value of $13,000 at the end of the lease, your monthly leasing rate will be based on $7,000 (the value of the car you will have "used up" after the 24-month lease). That's why the payments for leasing are less than the payments for buying and why some people prefer to lease.

Four steps to lease a car

1. Negotiate a price for the car with a dealer . Many people believe that if you lease you have to pay full price. That's not true. Your negotiated price will affect the lease rate, so it's very important to negotiate your best price, just as if you were buying the car.
2. Sign the lease contract with the dealer. The dealer acts on behalf of the leasing company when working out the leasing agreement with you. He or she will usually receive a commission from the leasing company for this service. Signing a leasing contract means that you agree to make regular monthly payments, keep appropriate insurance, pay any vehicle taxes and licensing fees, and take good care of the vehicle. You also agree that you'll keep the car for the specified number of months in your lease, typically 24, 36, or 48 months. There is no easy way to terminate a lease or swap to another vehicle once you've signed the leasing agreement, so be sure that you have read and understood all the details of the leasing agreement. Once you've signed the lease contract with the dealer, the dealer sells the car to the leasing company at the price you've negotiated.
3. Pay the leasing company your leasing fee each month.
4. Return your vehicle to the leasing company at the end of your lease with no more than normal wear and tear. You'll have to pay for any damage or extra mileage over and above your contract-specified limits.

(Any reference to a specific company, commercial product, process, or service does not constitute or imply an endorsement or recommendation by CashCourse or the National Endowment for Financial Education. These courses and related resources may be used only for nonprofit, noncommercial educational purposes. CashCourse makes every effort to keep the information in these courses current, but, over time, new developments as well as legislative and regulatory changes may date this material. If you discover inaccurate information, please contact us.)