The short version
When you lease, you pay for the car's expected drop in value over the lease, plus a rent charge (the lease's version of interest), plus taxes and fees. At the end, you return the car unless your lease lets you buy it. That's why lease payments are usually lower than loan payments on the same car: you're paying for part of it, not all of it.
The five numbers that set your payment
1. Capitalized cost (cap cost). This is the price of the car in the lease, plus any fees or extras rolled in. It's negotiable, just like a purchase price. A cap cost reduction is a down payment, trade-in credit or rebate that lowers it. What's left is the adjusted cap cost.
2. Residual value. The lessor's estimate of what the car will be worth at the end of the lease, written into the contract. It's usually shown as a percentage of the MSRP. A higher residual means less depreciation to pay for, so a lower payment.
3. Money factor. The lease's finance rate, written as a small decimal like 0.0025. To compare it with a loan APR, multiply by 2,400: 0.0025 × 2,400 = 6% APR.
4. Term. The number of months, often 24 to 48.
5. Mileage allowance. The miles a year you can drive without extra charges. The FTC says the annual limit in most standard leases is 15,000 miles or less.
How to calculate a lease payment
Rent charge = (adjusted cap cost + residual) × money factor
Payment = (depreciation fee + rent charge) × (1 + sales tax rate)
Example. A car with a $40,000 MSRP is negotiated to $38,000. You put $2,000 down, so the adjusted cap cost is $36,000. The residual is 58% of MSRP, so $23,200. The lease is 36 months at a money factor of 0.0025 (6% APR), with 7% tax on the payment.
- Depreciation fee: ($36,000 − $23,200) ÷ 36 = $355.56
- Rent charge: ($36,000 + $23,200) × 0.0025 = $148.00
- Before tax: $503.56; with 7% tax: $538.80 a month
Try your own deal in the auto lease calculator.
How to calculate residual value
On a $40,000 MSRP with a 58% residual, the residual value is $23,200. The residual is set by the lessor, not by you, but it matters: it's also usually the price to buy the car at the end if your lease includes a purchase option.
Mileage, wear and tear
If you go over the mileage limit, expect a per-mile charge when you return the car. The limit and the charge are both in your lease. You're also responsible for excess wear and damage and any missing equipment, judged by the standards in your contract, such as tire tread and body damage. Before signing, estimate your real yearly miles; buying extra miles upfront is usually cheaper than paying for them at the end.
Ending a lease early
Leases are hard to get out of. The FTC warns that ending a lease early may mean a substantial early termination charge, and the Federal Reserve's leasing guide notes these charges tend to be larger the sooner you end the lease. Read the early termination section of your contract before you sign.
At the end of the lease
You return the car, pay any mileage and wear charges, and may owe a disposition fee if your lease has one. If your lease has a purchase option, you can buy the car instead for the price set in the contract.
How to lease a car: step by step
- Know your budget and your real yearly mileage.
- Get preapproved for a loan too, so you can compare leasing with buying.
- Negotiate the cap cost (the price) first, and ask for the money factor and residual in writing.
- Convert the money factor to an APR (× 2,400) and compare it with your loan offer.
- Read the federal lease disclosures. Regulation M requires the lessor to show the amount due at signing, the payments, and the other charges before you sign.
- Check the mileage allowance, the overage charge, the wear standards and the early termination terms.
Lease or buy?
Leasing tends to suit people who want a new car every few years, drive predictable miles and don't want to deal with selling. Buying tends to cost less if you keep a car long after the loan is paid off. Run both with the lease vs buy car calculator.