How Do You Lease a Car and How Much Does Leasing Cost?

Car leasing is more like renting than owning – but it feels like owning. And it remains a popular way to finance a car regardless of fluctuations in the economy: slightly more than 18% of all new vehicles were leased in the third quarter of 2022.¹ Perhaps you’re ready for a new set of wheels and are considering whether to lease it. But first it may be helpful to understand the mechanics of car leasing – what it means, how it works, the pros and cons, and, like any contract, the fine print.  

A car lease specifies the amount of time a vehicle will be in your possession and the number of miles you can drive before incurring an extra cost. Why would you want this rental-style deal instead of buying? Generally speaking, the pros of car leasing over buying include lower monthly payments and the ability to negotiate a low down payment.² For example, according to Experian, the average monthly car lease payment is $143 less than the average monthly new-car loan payment.³

And car leasing is great if you enjoy driving the latest wheels on the market because the average length of a lease is two to four years – you might be moving on to the next model before you know it.²

Of course, leasing a car doesn’t make sense for everyone. For example, experts say buying is less expensive over the long term, so buying may make more sense if you prefer to keep your car for longer than the typical lease length.⁴ If you buy, you can drive the car without mileage limits or penalties, and once you’ve paid off the loan, you own it. If you have a mediocre or poor credit history, you’ll probably find it easier to qualify for a loan than for a lease.⁴

Of course, how much it will cost to lease a car is an important consideration. That brings us to the concept of depreciation, which drives the long-term value of a car and the total cost to own one. From the second a car leaves a dealer’s lot, it begins to decrease in value. Vehicle depreciation is the rate of that decrease in value. Experts peg average car depreciation at around 20% in the first year of its lease and 15% each year thereafter.⁵ In other words, the car will be worth a lot less when your lease has ended.

The dealer’s goal is to get maximum value from the car when it’s returned at the end of the lease. To ensure that happens, the basic financial terms of a car lease are structured so the cost to lease – what you pay – offsets the depreciation.² Since cars all depreciate at different rates, an online car depreciation calculator can come in handy for an approximation of the decrease in value before you head to the dealership.

To understand how much it may cost to lease a car, it’s helpful to know some car leasing terminology.

• Capitalized cost, or “cap cost,” is basically the price of the car. Discounts on that price – such as leasing incentives offered by the manufacturer – are known as cap cost reductions.⁶
• Residual value is what the dealer anticipates the car will be worth at the end of the lease.²
• Money factor is leasing lingo for the interest rate you’ll pay.⁶ If a dealer quotes you a money factor of .00125, multiply that by 2,400 to get the equivalent annual percentage rate (APR). Now you’re looking at a more familiar 3% interest. An online money factor calculator can do the math for you if you prefer.
• Drive-off costs are what dealers label the down payment required, along with sales tax and any other upfront fees you have to pay, such as DMV and leasing fees and a security deposit.⁶

Now, let’s do the math. In simplest terms, the typical formula for how much it costs to lease a car is the capitalized cost minus the residual value plus interest and fees. For example, if your dream car has a cap cost of $35,000 and a residual value of $20,000 after three years, then you’re on the hook for $15,000 plus interest and fees.

Because your payment is driven by the cap cost, the lower the better.

Beyond the financial terms of the lease, the agreement will include components to help protect the car’s value. Conceptually, these are akin to the conditions you accept when you rent a car, but on a larger scale. These include:

• Mileage limits. A typical lease will allow you to drive 10,000-15,000 miles per year, after which you’ll pay mileage penalties.² Those penalties usually start at about 10 cents per mile but may be more than three times that.⁷ You can negotiate for higher mileage limits, but doing so may cost you more every month.⁸
• Wear and tear limits. Dealers understand you can’t drive a car for three years without some minor deterioration from everyday use, such as a small stain or scratch that can be buffed out. However, they will likely charge you for certain kinds of damage or for what they deem “excessive” wear and tear.^2,6 For example, you may be asked to replace worn tires. Also, don’t be surprised if you have to pay for damage to the glass or for dings that are larger than the size of a credit card.
• Restricted use. Some leases may not allow you to take the car out of the country without permission, or to use the car to drive for a ridesharing service.^9,10

Finally, be aware that the unique nature of leasing has implications for insurance, fees, taxes – which vary from state to state – and other costs. For more information, see “How To Lease a Car & Negotiate Your Lease Deal.”