What Is Leasing a Car? How It Works and What It Costs

When you lease a car, you are essentially renting it from the leasing company (typically a dealership's financial arm or a captive finance company) for a predetermined number of months and miles. At the start of the lease, three key numbers are negotiated: the capitalized cost (the agreed price of the car), the residual value (what the car is projected to be worth at lease-end), and the money factor (the interest equivalent, similar to an interest rate). The CFPB's auto loan guide explains these terms in detail.

Your monthly payment is calculated primarily on the depreciation — the difference between the capitalized cost and the residual value — spread over the lease term, plus a finance charge based on the money factor. The higher the residual value relative to the capitalized cost, the lower your monthly payment. This is why vehicles that hold their value well (such as certain Honda, Toyota, or luxury models) often have attractive lease deals. Understanding how interest works on a car loan helps you compare the money factor to traditional financing.

Understanding these terms helps you evaluate and negotiate a car lease:

• Capitalized cost ("cap cost"): The agreed selling price of the vehicle. This is negotiable — a lower cap cost means lower monthly payments.
• Residual value: The predicted value of the car at lease-end, expressed as a percentage of MSRP. Set by the leasing company, not negotiable. A higher residual value lowers your payment.
• Money factor: The interest rate equivalent for a lease. To convert a money factor to an APR, multiply by 2,400. For example, a money factor of 0.0025 equals approximately 6% APR.
• Acquisition fee: A fee charged by the leasing company to originate the lease, typically $400–$900. Often non-negotiable.
• Disposition fee: Charged at lease-end if you return the car and do not lease or buy another vehicle from the same brand. Typically $300–$500.
• Mileage allowance: Most leases allow 10,000 to 15,000 miles per year. Excess miles incur per-mile charges (typically $0.15–$0.30 per mile) at lease-end.

The CFPB recommends reviewing all lease terms carefully before signing. If you later decide to exit early, understand the costs associated with trading in a car that is not paid off. Also review instant auto insurance options before picking up your leased vehicle.

The CFPB outlines several important differences between leasing and financing a vehicle purchase. Leasing typically offers lower monthly payments but you build no equity in the vehicle. Buying (whether with cash or a loan) means you own the vehicle outright once the loan is paid off and can sell or trade it at any time.

Leasing suits drivers who prefer new vehicles every few years, drive within the mileage allowance, and maintain the car in good condition. Buying suits drivers who keep vehicles long-term, drive high mileage, or want to modify their car. From a long-term cost perspective, perpetual leasing is generally more expensive than buying and holding a vehicle for many years, because you continuously pay for depreciation without accumulating any asset value. If you are considering refinancing an existing auto loan instead of leasing, see how many times you can refinance a car.

As a lessee, you are responsible for keeping the vehicle in good condition, staying within the contracted mileage limit, and maintaining required insurance coverage. Most lease agreements require you to carry comprehensive and collision coverage with relatively low deductibles — check your lease contract for specific insurance requirements. The FTC's consumer guide covers what lessees are responsible for under standard lease agreements.

At lease-end, the leasing company inspects the car for "excess wear and tear" beyond what is considered normal. Charges can apply for dents, interior damage, missing parts, or tires below a minimum tread depth. Request a pre-inspection appointment (many lease companies offer this for free or a small fee) about 60 to 90 days before your lease ends so you can address issues before the final inspection. For insurance questions, see our guide on how long insurance companies have to investigate a claim.

When a car lease ends, you typically have three choices. First, you can return the vehicle, pay any applicable fees (excess mileage, wear and tear, disposition fee), and walk away. Second, you can purchase the vehicle at the predetermined residual value stated in your lease contract — this can be a good deal if the actual market value of the car exceeds the residual value. Third, you can lease or buy a new vehicle from the same dealership, which often allows you to avoid the disposition fee.

Before deciding to buy out your lease, compare the residual value in your contract to current market prices for the same vehicle. Resources like Kelley Blue Book (kbb.com) or the NADA Guides provide market value estimates. If the residual value is lower than the current market value, buying the leased car may be financially advantageous — you would effectively be buying a used car for below-market value. The CFPB recommends comparing this option carefully. If you have equity in the vehicle, also consider understanding how to maximize insurance value if an accident ever occurs.