If you are in the market for a new car, you may be mulling over leasing as a path to lower monthly payments. This situation is probably even more likely if your budget is already stressed, leaving little room for a hefty car payment. A household budget at the bursting point sometimes goes hand in hand with a less than sterling or even poor credit history. Consequently, the first answer you need is: Is there such a thing as leasing for buyers with bad credit?
The answer is yes, but it’s not an easy (or necessarily the best) solution for anyone battling an overtaxed budget.
Leasing isn’t for everyone. It’s often a tool for writing off a vehicle as a business expense to reduce taxes. And some well-heeled drivers want to upgrade to a new car every couple of years without the hassle of disposing of a used one. Otherwise, leasing roles contain everyday people who believe leasing is an excellent way to reduce monthly payments. It isn’t, but that’s a subject for another day.
We won’t detail the drawbacks of leasing for the average consumer here. Instead, we’ll address the ins and outs of leasing with bad credit rather than the merits of leasing in general.
- Why Lease?
- How High a Credit Score Do You Need to Lease a Car?
- What You Need to Know When Leasing with Bad Credit
- Your Leasing Options
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Why Lease?
Leasing typically translates into a lower monthly payment than traditional financing, which can be attractive to anyone with a stretched budget. Consider this example.
A 2022 Nissan Sentra S costs $20,835, including the factory destination charge. If you finance for 36 months through Nissan with no money down, the monthly loan payment would be $587. Stretching the term to 60 months reduces the monthly payment to $378. The Nissan-advertised 36-month lease with $348 down comes with a payment of $348 per month. In either case, leasing will save on the monthly payment compared to a traditional auto loan. However, Nissan only offers these loan and lease deals to consumers with solid credit.
Why are Lease Payments Lower?
Without wading too far into the tall grass, there is a simple reason why leasing payments are lower. With traditional financing, you make payments toward owning the car. The car is yours when you’ve made that last scheduled payment on a loan.
That’s not the case with leasing. Leasing is basically a long-term car rental. A leasing company owns the vehicle and rents it to you for an extended period (usually two to four years).
Your monthly payment covers the value the car loses (depreciation) during the lease term while in your possession. You have no further obligation at the end of the lease except for some possible fees. If you fulfill your monthly commitment, stay within the annual mileage limit and return the vehicle in good shape, you walk away. The leasing company then disposes of the car.
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How High a Credit Score Do You Need to Lease a Car?
If we could foresee the lowest credit score you can have and still lease a car, we’d buy a lottery ticket. That’s a flip response to a serious question without a concrete answer because it depends on many considerations. Each leasing company has its internal requirements for approving a lease. And yes, other factors contribute to that decision. When evaluating a loan or lease application, your credit score is the initial factor lenders examine.
We can confidently say that a lease typically requires a higher credit score than a traditional car loan because the vehicle isn’t yours during the lease term. The leasing company knows that you have no (or very little) skin in the game.
You will have a rough go of it with a credit score below 660, and it’s even more challenging when below 600. However, qualifying for a lease with a low credit score isn’t impossible. According to the credit experts at Experian, in the fourth quarter of 2021, consumers with a credit score between 601 and 660 made up nearly 14% of the leasing market. Those with a credit score below 600 represented just over 5%. In other words, about 19% of lessees at the end of 2021 posted credit scores of 660 or lower.
How to Find Your Credit Score
Credit reporting agencies compute scores differently, so your score may vary slightly from one to the next. Moreover, credit scores are snapshots of your creditworthiness at any given moment. They can change from month to month or even week to week. To get your credit score, you can reach out to any of the three national credit bureaus — Experian, TransUnion, or Equifax. They have a legal obligation to provide one free credit report per year to anyone formally requesting it. That report will include your credit score.
Alternatively, you can sign up for a credit monitoring service and check your score. Many free and low-cost services are happy to give you a peek behind the financing curtain.
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What You Need to Know When Leasing with Bad Credit
A sad reality of having poor credit is that even if you get approved for a loan – any loan – or a car lease, it will probably cost you more than someone with gold-plated credit. If your credit score is 600, a lease will cost you more than the person next to you with a score of 800. That’s just how lending works. Lending is all about risk management. Lenders assign higher interest rates to borrowers with poor credit, while less-risky customers get lower rates.
Down Payment and Deposits
In leasing, the final amount on which the lease payments are based is called the “adjusted capitalized cost.” Consequently, the down payment, trade-in, and so forth is called a “capitalized cost reduction.” Here it’s just what it sounds like: It reduces the amount used for calculating the lease payments.
No matter what you call them, down payments achieve two goals. First, they reduce the amount financed, which reduces the monthly payments. Second, a down payment ensures the borrower has a more significant stake in fulfilling their commitment. The larger the down payment, the bigger the stake and the more invested the borrower is in a successful outcome. That is, the less likely a borrower will default.
With a traditional loan, the down payment has a third effect: More rapidly building equity in the vehicle. It doesn’t have that impact on a lease. A down payment in leasing is a balloon rental payment on the front end of the lease. In the eyes of the leasing company, the bigger the upfront payment, the smaller the monthly payments, and the lower the risk of default. Therefore, be prepared to pony up.
In addition to a capitalized cost reduction, the lessor may also require a deposit. If all goes according to the contract, your deposit goes back to you at the end of the lease.
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Interest Rate
Borrowing money costs money. Anytime you use someone else’s money in a loan or lease to purchase something, there’s a cost. You will pay some percentage of the amount borrowed as a fee to use that money. In financing, that fee is called “interest.” It’s known as APR (annual percentage rate). The higher the APR, the greater the monthly payment.
Interest rates are expressed as 3% APR, 3.5% APR, etc. A single percentage point can make a big difference. For example, borrowing $20,000 for 60 months at 3% interest works out to $359 per month. In other words, you will pay back a total of $21,540 over 60 months. Borrowing the same amount for the same term at 4% interest equals a monthly payment of $368. Here, the total payback is $22,080. That’s a difference of $540. That’s $540 you won’t have to spend on other things such as food.
The interest rate in leasing isn’t an interest rate at all. Yes, there is a charge for using the lessor’s money, but it’s called the “money factor.” When expressed as a money factor, it looks something like 0.00278. The lower the number is, the better for the lessee. To translate this number into the approximate APR, multiply it by 2,400. (0.00278 x 2,400 = 6.67) In this example, the money factor is roughly equal to 6.67% APR. If the lessor represents the money factor in an APR form (in this case, 2.78), use 2.4 as the multiplier (2.78 x 2.4 = 6.67).
As with a loan, the weaker the borrower’s credit is, the higher the lease’s money factor will be because it will reflect the lessee’s additional risk.
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Your Leasing Options
There are better alternatives for consumers with weak or damaged credit than leasing. A traditional loan makes more sense when getting a car, creating equity, and rebuilding your credit. True, your payments may be higher, but you will own something in the end. That something is a car that is yours to later sell or trade for a newer or better model.
If your only goal is securing the smallest monthly payment possible, leasing could fulfill that desire. We suggest you may have a better chance of leasing a used car. The money factor for used-car leases is usually higher than for new vehicles. However, the lost value you must cover with lease payments will be less because the worst depreciation years have already passed.
Another suggestion is to investigate assuming someone else’s lease. Although you still must pass the approval process, a lease transfer might allow you to avoid some of the upfront costs of leasing because the original lessee has already paid them. There are lease brokers like SwapALease and LeaseTrader specializing in matching current lessees wishing to get out of their lease with people who want to assume a lease.
