Leasing a car is similar to financing in many ways, but there are some key differences. When you are purchasing a car, the loan value is based on the entire cost of the vehicle, minus your down payment and trade-in value. When leasing, however, you’re only financing the depreciation that occurs during the lease term (most commonly three years), plus fees. At the end of the lease term, you simply return the car to the dealership.
So, unless you pay a tremendous amount of money down, or your trade-in had a high value, a monthly lease payment will be lower than a monthly loan payment. With the car lease, you only pay the difference between the car’s price and what it’s expected to be worth at the end of the lease, which is known as its residual value.
It’s helpful to look at some numbers. Say your dream car is a new SUV that costs $30,000, you’re able to put 10 percent down ($3,000), and don’t have a trade-in. You’ll need to finance $27,000.
With any lease, there will be a predetermined residual value. Let’s say, for our example, that it’s 55 percent, or $16,500. That means you’ll only make payments on the $13,500 worth of use that you’re expected to get from the vehicle. That’s half the price of the outright purchase. It’s not quite that simple – both types of deals generally come with fees that need to be included in the math – but that gives you an idea of why lease payments are generally lower than financing payments.