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Leasing Basics

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Jon Acuff is a staff writer for AutoTrader.com.

Why are leases so popular?

The simple answer is "Leases offer lower monthly payments on higher quality cars."

That's true, in many cases a lease allows you to make lower monthly payments on cars that might normally be out of your price range.

However, as soon as you start researching leases, you'll realize that very little about this financing method is simple. You could fill an encyclopedia with the benefits, mechanics and potential complications of a lease.

But no one wants to take an encyclopedia on a visit to a dealership. In this article, we'll provide some clarity with a quick walkthrough of what a lease is, how it works and what the benefits are.

What is a lease?

In the simplest terms, a lease is similar to renting a car for a longer term. It is a financing agreement in which you promise to pay any up-front costs, make monthly payments and maintain a car over a fixed period of time.

At the end of the lease period, you return the car. If you drove further than what was stipulated at the start of the lease, the leasing company will usually charge you an additional per mile fee. If there is excessive wear and tear, you'll be required to repair the damage. Or, you'll typically have the option to purchase the car at the end of the lease for a price determined at the beginning of the lease.

How does a lease work?

Lease payments are based on a number of factors. At a high level, they reflect the current value or "capitalized cost" of the vehicle, the future or "residual" value and how much the vehicle will depreciate in the time you use it.

For instance, let's say you're looking at a sports car and an SUV. Each one is selling for $30,000, which represents the current value of the vehicles. The leasing company projects that after three years, the SUV should be worth $22,000, and the sports car should be worth $18,000. In this case, it would cost less to lease the SUV because it will be worth more to the leasing company when all is said and done. Although they both started out with the same initial price, the SUV is expected to maintain a higher residual value and therefore will depreciate less than the sports car. Lower depreciation equals a lower lease payment. Think of the depreciation amount as the "cost" of the "rental."

The easiest way to see the math behind a lease is to use our Purchase vs. Lease Calculator. You'll get an instant look at the differences between these two popular financing methods.

What are the benefits of a lease?

  1. Lower monthly payments
    On average, your monthly payments with a lease are lower than they are on a loan. This is due to the fact that you're only paying for the portion of the car's value you are using as opposed to the full value with a loan.
  2. Less commitment, more freedom
    At the end of the lease, complications associated with answering the question "what do I do with this car" are removed. Simply fulfill your obligations and bring the car back to the leasing company.
  3. Lower taxes
    As with any tax issue, read the fine print. However, in many states, you pay tax only on the part of the car's value you use throughout the lease agreement, not the complete sales price of the car. Businesses can also enjoy the tax advantages of leasing, which are certainly worth exploring.
  4. New car, new features
    With a lease, you can essentially drive a new car every two-to-three years. Plus, with lower payments, you can also afford a nicer car than you ordinarily could with a loan. Whether that means stepping up to the Limited Edition with extra features or getting your family a model with the latest safety advances, the option to upgrade is yours.
  5. Gap protection
    If your leased car is stolen or significantly damaged in an accident forcing you to terminate the agreement, gap protection is critical. It covers the difference between the payoff from your insurance company and the amount of money you still owe on the lease. Many leases include free gap insurance or offer it at a nominal fee, which most loans do not.
  6. Less warranty worries
    Most leases are for new cars and have terms structured within the manufacturer's warranty period. For instance, a three-year lease would fall well within a five-year standard warranty. When the check engine light comes on with your new leased car, there's no need to worry because it's probably still covered by the new car warranty. Just bring it back to the dealership for service.

If you'd like to know more about leasing, read 5 Signs You Might Love a Lease. To learn about the loan side of the car financing world, take a look at Loan Basics.

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