Lease vs buy a car: how leasing works and which costs less

Leasing gives you lower monthly payments and a new car every few years, but you never own anything at the end. Buying costs more per month at first, but once the loan is paid off you keep a car with real value. If you drive a lot or keep cars for many years, buying almost always wins; if you want a new car every three years and drive predictable miles, leasing can make sense.

The right answer depends on the numbers in your specific deal, so here is how a lease is priced, what the fine print costs, and a worked three-year comparison.

How a car lease works

When you lease, you pay for the part of the car's value you use up during the lease, plus a finance charge and fees. Four numbers drive the payment.

Capitalized cost

The capitalized cost, or cap cost, is the price of the car in the lease. It is negotiable, just like a purchase price. Fees you roll into the lease add to it; a down payment or trade-in (a cap cost reduction) lowers it.

Residual value

The residual value is the leasing company's estimate of what the car will be worth at the end, set as a percentage of MSRP. A higher residual means less depreciation to pay for and a lower payment. Residuals are generally not negotiable.

Money factor

The money factor is the lease's interest rate in a different format. To convert it to an approximate APR, multiply by 2,400: a money factor of 0.00250 equals about 6.0% APR. Dealers can mark up the money factor above the leasing company's base rate, so ask for it in writing and compare it with the auto loan rates you qualify for.

Fees

Most leases charge an acquisition fee at the start, commonly several hundred dollars to around $1,000, and a disposition fee when you return the car, commonly a few hundred dollars. Sales tax treatment varies: many US states tax each monthly payment rather than the full price, but rules differ by state and province, so check yours.

How the payment is calculated

The monthly payment has two parts. The depreciation charge is the cap cost minus the residual, divided by the number of months. The finance charge is the cap cost plus the residual, multiplied by the money factor. Add them together, then add tax.

Mileage limits, wear and early exits

A lease is a contract with conditions, and breaking them costs money.

• Mileage limits. Common allowances are 10,000, 12,000 or 15,000 miles a year. Excess miles commonly cost around 15 to 30 cents each at turn-in; at 25 cents, going 3,000 miles over adds $750. Buying extra miles up front is usually cheaper than paying the penalty.
• Wear and tear. Normal wear is expected, but you'll be billed for damage beyond the lessor's guidelines: dents larger than a set size, curbed wheels, worn tires, stained upholstery or cracked glass. Get a pre-return inspection so you can fix issues more cheaply yourself.
• Early termination. Ending a lease early can be very expensive. You may owe the remaining payments, or the gap between your payoff and the car's value, plus an early termination fee. Alternatives include a lease transfer, if your lessor allows it, or buying out the lease and selling the car.
• Insurance. Lessors usually require collision and comprehensive and often higher liability limits than your state minimum. Check whether gap coverage is included; many leases include it.

Buying: the pros and cons

When you buy, you finance the full price or pay cash, and the car is yours.

• Pros: no mileage limits, no wear charges, freedom to modify or sell whenever you want, and years of driving with no payment once the loan is paid off. Your car keeps resale or trade-in value.
• Cons: higher monthly payments for the same car, a larger down payment to avoid owing more than the car is worth, and repair costs once the factory warranty expires. You also carry the risk that the car is worth less than expected when you sell.

Estimate your loan payment with the car payment calculator, and see how auto loans work for rates, terms and down payments.

A worked 3-year cost comparison

Here is the same car leased or financed, with both deals measured at the 36-month mark.

Assumptions

• MSRP $35,000, negotiated price $33,000 for both lease and purchase
• Lease: 36 months, 12,000 miles a year, residual 58% of MSRP ($20,300), money factor 0.00250 (about 6.0% APR), $695 acquisition fee rolled into the cap cost (adjusted cap cost $33,695), $395 disposition fee, no down payment
• Buy: $3,000 down, $30,000 financed at 6.0% APR for 60 months
• The car's market value at 36 months equals the lease residual, $20,300
• Sales tax, registration and insurance are left out, since they vary by location

The lease payment is $372.08 of depreciation ($13,395 ÷ 36) plus $134.99 of finance charge ($53,995 × 0.00250), or $507.07 a month before tax. The loan payment is $579.98 a month, and after 36 payments about $13,086 is still owed.

After 36 months	Lease	Buy
Upfront payment	$0	$3,000
Monthly payment	$507	$580
Payments over 36 months	$18,255	$20,879
End-of-term fee	$395	$0
Total paid	$18,650	$23,879
Equity you keep (value minus loan balance)	$0	$7,214
Net 3-year cost	$18,650	$16,665

In this example, buying costs nearly $2,000 less over three years, mostly because of the lease fees and a finance charge calculated on both the cap cost and the residual. The buyer's net cost equals the car's depreciation ($12,700) plus the loan interest paid (about $3,965).

Change one assumption and the result flips. If the car is worth only $17,000 at three years instead of $20,300, the buyer's net cost rises by $3,300 to about $19,966, more than the lease, while the lessee simply hands back the keys. That protection against a bad resale value is the lease's real advantage. Run your own figures in the lease vs buy calculator, and check likely resale values with the depreciation calculator.

Who should lease and who should buy

Leasing tends to suit you if you

• Drive a predictable number of miles that fits within the allowance
• Want a new car every two to four years, always under factory warranty
• Keep cars in clean condition and don't plan to modify them
• Value a lower monthly payment over long-term ownership
• Want protection if the model's resale value drops sharply

Buying tends to suit you if you

• Drive more than about 15,000 miles a year
• Keep cars for six years or more
• Want to customize, tow heavily or use the car hard
• Want to stop making payments eventually

Business owners may treat lease and loan costs differently for tax purposes; ask a tax professional. Outside the US the products differ: in the UK, personal contract hire is the closest match to a lease, and lease rates and taxes in Canada vary by province.

The lease buyout option

Most leases let you buy the car at the end for a price fixed in the contract, usually the residual value plus any purchase option fee and tax. That makes the buyout a useful hedge. If the car is worth more than the buyout price, you can buy it at a discount or, where your lessor allows, sell it and keep the difference. If it is worth less, you simply return it.

Before you buy out, compare the buyout price with real market offers, have the car inspected if you plan to keep it, and line up financing, since you may need a loan for the balance. Some leasing companies restrict or prohibit sales to third-party dealers, so read your contract and ask early. The Consumer Financial Protection Bureau also explains the trade-offs between leasing and buying.

The bottom line

Lease when you value a low payment, a new car every few years and protection from resale risk, and you're confident about your mileage. Buy when you drive a lot or plan to keep the car long after the loan is gone. Either way, negotiate the price first, get the money factor or APR in writing and compare total cost, not the monthly payment. This guide is general information, not financial or legal advice.