What does it mean to lease a new car? Essentially, leasing is similar to renting — you make payments for the use of the car over a certain time period, and you return the car at the end of that period. Most likely, you will lease a car for 2-3 years and then have the option of buying the car or giving it back to the dealer. There is no cut and dry choice when determining whether leasing or buying is the better choice; your economic situation and how you intend to use the car will play the largest role in your lease vs. buy decision.

Whom am I leasing the car from?

You are not leasing the car from the dealership that you bought it from. You are leasing it from a finance company. The car is "sold" to the leasing company by the dealer and then that company leases it to you.

What are the different types of leases?

The two main types of leases are:

Closed-end lease

The most popular consumer lease. Closed-end leases allow you to walk away when the lease is over. At the time of the lease, the leasing company determines the estimated lease-end value, or residual value, of the car. If you return the car at the end of the lease and it is worth less than the estimated residual value, the leasing company takes the hit. All you are responsible for is any excess mileage and wear-and-tear fees. If you really like the car and want to keep it, there is generally an option to purchase the car when your closed-end lease runs out.

Open-end lease

Open-end leases require you to purchase the vehicle at the end of the lease. You will have lower monthly payments than with a closed-end lease, and you will have to pay the residual value once the lease is up. If the calculated residual value happens to be lower than the actual market value at the end of the lease, then you'll get a deal because you will be able to sell the car for a profit. There aren't any excess mileage or wear-and-tear penalties assessed, but there is an element of risk involved. Open-end leases are popular among businesses and fleets that can negotiate better prices and buy in quantity.

Why do leases have lower monthly payments than loans?

When you take out a loan to purchase a car, you are paying the entire purchase price plus interest over a fixed period of time. When you lease a car, you are paying the difference between the purchase price and the projected residual value, and you only pay interest on that amount.

Example: You've negotiated and determined the price of a car to be $20,000. If you want to lease the car for three years, the dealer will determine what the car's value will be after the three years of depreciation. Let's say that after three years the car is estimated to be $11,000. Basically, you will be paying $9,000 (plus interest) over three years. If you choose to take out a loan, you will be paying $20,000 plus interest over three years, and therefore you will have higher monthly payments. But, you will own the car at the end of the three years.

Why You Want To Lease

1. Lower Monthly Payments

You are not paying for the whole car — just a portion. Monthly lease payments can be up to 60% less than purchase payments per month.

2. Always in Style

Evolve with the cars. Instead of driving the same car for 10+ years, you will be driving a new car every 3-5 years. If you look forward to new makes, models, and features, or if you like that new car smell, leasing is your ticket.

3. Are You Down with the Payment?

Because the total amount that you are paying over the course of your lease is significantly lower than if you were to purchase the vehicle, you aren't required to fork over as large a down payment (if any) when you sign.

4. Say Goodbye to the Shop

If you are leasing the car for 3-4 years, the odds of major maintenance issues are unlikely. If something were to occur, you should still be under warranty.

5. Save Money on Taxes

When you lease a car, you are paying the depreciated amount of the vehicle over the lease period. Therefore, you are only being taxed on that amount. Plus, you are not paying that tax in one lump sum — it's spread out over the course of your lease payments, similar to your insurance.

Why You Want To Buy

1. Equity City

When you make loan payments, you are gaining equity. Equity is ownership. At the end of your loan, you will own your car. When your lease is up, you will have nothing to show other than a bunch of payment slips.

2. You Will Always Have a Car

Not only will your purchased car become an asset, but the bottom line is that you will still have a car after the loan has been paid off and you'll have no more car payments. If you lease, you will have to return your car and lease another one.

3. Financial Freedom

When you are done paying for a car there are no more payments; there is a light at the end of the payment tunnel. If it takes four years of paying $500 per month to purchase a car but keep the car for an additional six years, you essentially paid $200 a month for 10 years. In addition to paying such a low fee over a long period of time, the car still has resale value.

4. Mileage Penalties

When you lease, you are usually allowed between 10,000-15,000 annual miles. If you think you will exceed that allotment, then you can buy extra miles at the point of purchase. You never know how much you'll actually drive — lots of things can happen during the course of your lease. If each mile over the limit is $0.25 and you end up going 6,000 miles over your allotted amount, you will owe $1,500.

5. Wear and Tear Penalties

What defines 'wear and tear' is a bit abstract. Most lease contracts define 'normal wear and tear' to mean that if you have any significant interior/exterior blemishes, you will be penalized.

6. Early Termination Penalties

Just like switching phone carriers in the middle of a contract. If you wish to get out of your lease early, it will cost you. If you lock yourself into a lease, be sure that you honor it — for money's sake.

7. Credit Check

Because leasing is the same as renting, your credit will have to be in better shape than if you were buying. You might need a co-signer. Check your free Experian® Credit Report & FICO® Score.

Leasing Vocabulary

When discussing a lease with the salesperson, you will hear several terms thrown around. If you don't want to be as confused as a newly thawed out caveman, then it's wise to know what they mean:

Residual Value

The predicted value of the car at the end of the lease.

Money Factor

Interest rates applied to leases are called money factors. Take the interest rate and divide it by 2,400 (it's always 2,400 even when the term is longer than two years). EXAMPLE: If the interest rate is 8%, divide 8 by 2,400 and you will get a 0.0033 money factor.

Term

The length of the lease in months.

BOTTOM LINE: The difference between getting a loan or lease comes down to how much money you can spend and the lifestyle you live. Buying makes the most financial sense and almost anyone can qualify for a loan. That being said, if you enjoy driving a new car every two to three years and money is no problem, then leasing is the way to go. The best advice is for you to do the fiscally responsible thing and stay within your means whether you choose to buy or lease your new car.