What to Know Before Signing an Auto Lease

A lease payment is built from two main components. The first is depreciation: the difference between the vehicle's negotiated price and its “residual value,” the amount the leasing company predicts the car will be worth when the lease ends, spread out over the lease term. A vehicle that's expected to hold its value well has a higher residual value and a lower monthly payment, since there's less depreciation to cover - this is why some models lease far more cheaply relative to their price than others. The second component is the finance charge, expressed not as a familiar interest rate but as a “money factor,” a small decimal figure; multiplying the money factor by 2,400 gives a rough equivalent APR, a conversion worth doing before comparing a lease offer to a loan. A down payment or trade-in value applied to the lease is called a “capitalized cost reduction” and lowers the monthly payment, though putting significant money down on a lease is generally considered less advantageous than on a purchase, since that money isn't building any equity in a vehicle you won't own.

The fine print matters as much as the headline payment. Leases specify an annual mileage allowance, commonly in the 10,000-to-15,000-mile range, with an overage fee - often 15 to 30 cents per mile - charged for every mile driven beyond it at lease-end; underestimating annual driving is one of the most common and expensive lease mistakes. Leasing companies also inspect the vehicle at return for “excess wear and tear,” which can mean anything from cosmetic scuffs to worn tires, and can bill separately for repairs beyond normal use. Because the leased driver never owns much equity in the car, gap insurance - which covers the difference between what's owed on the lease and the car's actual cash value if it's totaled or stolen - is far more important on a lease than on an owned vehicle, and many leases require it. At the end of the term, a lessee typically has three options: return the car and walk away, buy the car at its predetermined residual value, or, less commonly, extend the lease month to month - and comparing that residual buyout price against the vehicle's actual market value at lease-end can occasionally reveal a genuine bargain if the car outperformed the leasing company's depreciation estimate.