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How Does Leasing a Car Work? 7 Steps to Get the Best Lease Terms

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This blog post was written by Scotty Abramson, former lead analyst on our growth marketing team and now Director of Growth at Two Chairs.

I’ll admit it upfront. I’m a transplant from New York City living in downtown San Francisco. I moved in August 2015 and was pleasantly surprised by the warm sunshine in September and October. But by the time summer 2016 rolled around, I was ready for the sun to be a bigger part of my life. I quickly learned that to actually enjoy warm California weather during the summer months I would need to leave the city and head any direction away from San Francisco. I needed a car.

Should I lease or buy a car?

Do you expect your car needs to be the same in three years? Do you take really good care of your things? Are you comfortable with the expected maintenance cost once the warranty expires and after normal wear and tear? Do you want to pay for the taxes and fees up front?

If you answered yes to all four questions maybe you should buy a car. I was no to all four and decided a lease was the best choice for me.

How does leasing a car work?

Once I decided to lease a car, I became obsessed with understanding how a car lease actually works. When you lease a car, you are responsible for paying the depreciation between the purchase price and the value the manufacturer is willing to buy the car back for at the end of the lease. On top of this depreciation, you will pay some interest to the manufacturer for lending you the money to purchase the car until you sell it back to them.

Understanding Lease Terms

So how does this work in practice? There are four main things that will determine your lease terms.

MSRP: This is the manufacturer’s suggested retail price; this is non-negotiable.

Capitalized Cost (Sale Price): This is the price you are paying for the car; this can and should be negotiated aggressively.

Money Factor: This is a representation of the interest rate you will pay on the money you borrow. This rate is set by the manufacturer but you should confirm you are getting the base rate (dealers will often try and mark this up.)

Residual Value: The price that the manufacturer will pay to buy back the car at the end of the lease (you also have the option to purchase the car at this price.) This price is also set by the manufacturer but again you should confirm the dealer is using the correct residual.


Maybe this seems like a lot to remember, but the most important thing is that leasing a car is every bit as negotiable as buying a car. How so? Remember, in practice, you are actually buying the car and then selling it back to the manufacturer at a pre-specified price in a pre-specified amount of time.

How to Lease a Car

Step 1: Figure out the car (make and model) you want to lease

Next, make an educated guess about the number of miles you will drive each year, and how long you would like the lease to last. This is the basic information you need before you can start to negotiate.

For example, I knew that I wanted a hatchback with manual transmission and preferred all-wheel drive; I estimated I would drive less than 10,000 miles per year and wanted a three-year lease. Ultimately, I chose the base model VW GTI. I sacrificed all-wheel drive to get the manual transmission and keep the car within my budget.

Leasing Pro Tip: Search for the best leasing deals online

If you are not fixed on the make and model, scour the internet for the best leasing deals in a given month. These great deals are just a starting point, though, and you should always negotiate. Also, it’s better to over-estimate your annual mileage to avoid overage charges at the end of your lease (dealers tend to charge between 15 and 30 cents for every mile over the limit.)

Step 2: Go to the local dealership and test drive the car

This gives you a point of contact at your most convenient dealership and, more importantly, confirms that you love the car and it satisfies your requirements. At this point, you don’t need to know every package/option you want. If your local dealership isn’t all that local, you might need to skip this step.

I went to the VW dealership in San Francisco and test drove the GTI. The plaid interior was cooler than I expected, and the electronics setup was slick. Driving the car made me feel alive; when that turbo kicked in, and I felt myself hugging the bucket seats, I knew this car was the one.

“Remember, in practice, you are actually buying the car and then selling it back to the manufacturer at a pre-specified price in a pre-specified amount of time.”

Step 3: Research new car inventory of your make and model at three to four other dealerships

Now you can start thinking about color, interior, and packages/options that you want. Request quotes for the vehicles you are interested in and ask the dealer to quote you the total drive-off, monthly payment after tax, as well as the MSRP, capitalized cost including the acquisition fee, money factor, and residual value. Specify that you only want to pay the first month’s payment and the registration fees as your down payment. You’ll be using these new quotes for your negotiation with the dealer where you did your test drive.

Leasing Pro Tip: Avoid putting money towards capitalized cost reduction

Do not put any money down that goes towards capitalized cost reduction. Dealers often use larger down payments to make monthly payments appear lower. This is almost always not in the best interest of the customer. If the car gets stolen or totaled the day after you lease it, you will not get any of your down payment back. I recommend you do not take this risk.

Step 4: Compare lease offers

Pay attention to all the details and not just the monthly payment. Which dealer offered the greatest percentage discount on the capitalized cost vs. MSRP? Did they make up for this by charging a higher money factor? Was the residual value consistent across all the dealers? Did some dealers quote you down payments that were larger than first payment plus registration fees?

Step 5: Negotiate a Better Lease

Now, confirm the manufacturer money factor and residual value for your make and model for the month (these numbers often change monthly). Pick the two additional dealers from above that had the most competitive offers. These will be the dealers who listened to your requests and quoted you the base money factor. Email these two dealers and ask if this is the best they can do. Suggest that you are looking for a monthly payment 20% lower than what they quoted.

Leasing Pro Tip: Use a leasing calculator

Use a lease calculator online to learn how different terms and down payments affect your monthly lease payment. While it is fun to plug in the inputs and watch the monthly payment change, you don’t need a calculator to negotiate and get a great deal.

Step 6: Choose the best final lease terms

Now it’s time to involve your local dealer again. Call the salesperson who helped you with your test drive and ask if he can beat the quote of your internet/email search winner. If he can beat their quote, you should repeat the process and ask the internet/email winner if they can beat your local dealer. As soon as one of the dealers refuses to improve, you should feel comfortable leasing the car from the other dealer knowing you didn’t leave too much on the table.

Step 7: Finalize your lease and drive away

Test drive the car you will be truly leasing and make sure it feels right. Confirm the details of the lease with your salesperson down to the penny before you authorize them to make a credit inquiry.

You will likely need proof of insurance to drive the car off the lot. If this is your first car, you can use one of the dealer’s recommendations or get many quotes online. I use Metromile, an online car insurance company, where you only pay for the miles you drive.

Finally, you will talk to the financial officer and sign the documents for your new lease. He is a skilled salesperson in his own right and will likely try to sell you on maintenance and protection programs. Simple strategy: say no to all. Congratulations—you now have a great new, leased car!

Happy Driving!

Save on your monthly car payment

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Disclaimer: This blog post provides personal finance educational information, and it is not intended to provide legal, financial, or tax advice.