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How Does Leasing a Car Work?

Okay, guys, we need to talk about something: the totally backwards logic of leasing a car. I get that the idea of driving around the latest, coolest set of wheels without having to buy it can be pretty tempting. But listen, the hit your budget takes as a result is not—and I repeat, not—worth it. You can’t build true wealth if you’re going into debt just to look rich.

Let’s break down what a car lease is and how it works so you can avoid losing time and money.

What Is a Car Lease?

A car lease is a contract where you pay in monthly installments to be able to drive a car for a certain period of time (usually two to three years). It’s kind of like a car rental—but unlike a rental, it’s a form of debt because the money for the lease comes from a bank or credit union, so you have to pay them back over time. A car lease will also show up in your credit score (which we all know is an “I love debt score”).

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Leasing also happens to be the most expensive way to drive a car. Payments are based on the residual value of the car (aka, how much it will supposedly be worth at the end of the lease). The monthly payments are calculated by totaling up the expected depreciation amount (or how much value the car will lose over time), rent charge, sales tax and fees and dividing that total number by the number of months in the lease.

You might be thinking, Fees? Sounds shady. What kind of fees? Well, there are a ton of front-end fees like the acquisition fee (what it costs to set up the lease), documentation fee (the cost of processing paperwork for the lease), title fee, registration fee and so on. When the lease is up, you have to fork over even more cash for the disposition fee (the cost of cleaning up and selling the car), excessive mileage fees if you go over the mileage limit, and excessive wear and tear fees if you don’t maintain the car up to the dealer’s standards.

And then, at the end of all that, you don’t even own a car—you have to give it back to the dealer. Do you see why this isn’t a smart money move?

In fact, it’s a complete rip-off. My good friend and mentor Dave Ramsey calls it “fleecing” because getting fleeced means getting financially taken advantage of—and it’s true. Like I said, it’s the most expensive way to operate a vehicle, so you’re definitely getting fleeced if you do this.

Leasing vs. Buying a Car 

Leasing is not the same as buying a car because you have to give it back at the end of your lease. Some car leases give you the option of buying when the lease is up, but hear me on this—that will end up costing you more in the long run because you still have to make the monthly payments throughout the lease term. The most affordable way to buy a car is used and with cash.

Leasing’s also not the same as getting a car loan. With a loan, you still keep the car once you pay it off, but until then, you make monthly payments on it. With a lease, you’re essentially making monthly payments to borrow it for a set amount of time. Both are forms of debt, and both are just ways to drive a car you can’t afford. Here’s a crazy thought: Buy a car you can actually pay for with cash. Then, if there’s a nicer car you really want, hustle and save up so you can pay cash for it in the future.

How the Leasing Process Works 

In case you missed it the last hundred times I said it, leasing is not a good idea. For anyone! As long as you’ve got that down, let’s talk about how people usually go about doing this—maybe without even realizing that they’re not actually getting any kind of a deal. Here’s how it happens:

1. Choosing a Car 

One of the most common motives for leasing a car is being able to drive a dope new car you wouldn’t be able to afford otherwise. So, this whole process usually starts with someone convincing themself that they need a certain type of car and deciding that they’ll do whatever it takes to (temporarily) get one.

2. Financing 

People typically go to a bank or credit union to get the funds (hint: this is debt). Financing can also be arranged through the car dealer, but that usually ends up being an even worse deal for the lessee (the person leasing the car) because the dealer is able to control the terms and set it all up in a way that benefits them most. Let’s be real: Financing is trouble, no matter where it comes from. We want to stay the heck away from debt.

3. Negotiating With the Dealer

This is another step in the process when the dealer can try to negotiate the lease price and interest in whatever way makes them the most money. Then the lessee makes a down payment, which also has an effect on the size of the monthly payments (a lower down payment equals higher monthly payments, for instance). Sometimes the lessee is required to pay the first and last months’ payments up front too—yikes.

4. Driving and Maintaining the Car 

This is the part where the lessee drives around flexing on their neighbors for a few months until the lease is up. But they have to make sure they keep the car in perfect condition and be careful not to go over the mileage limit if they don’t want to pay any more fees.

5. Returning the Car to the Dealer 

Once the glorified joy ride is over, it’s time to turn the car back in and hand over the disposition fee, along with any other fees that might’ve been racked up throughout the lease period. And the worst part is, the lessee doesn’t even have anything to show for all that money they spent.

Why You Shouldn’t Lease a Car 

So, by now, hopefully you can see why leasing a car isn’t a good move. But just in case you’re still on the fence because the thought of driving around a brand-new Mercedes is just so hard to resist, here are a few more things to think about:

  • Depreciation makes you lose money. All cars go down in value. Let’s say a new luxury car loses $50,000 in value over a two-year period. If you lease it, that loss in value has to be factored into the lease payment or the leasing company loses money. And they’re not going to set themselves up to lose money—so your bank account is going to take the hit.
  • It’s hard to get out of the lease early. You can’t just return the car early if you get tired of it. Anyone who wants to break a car lease for any reason is in for a huge, expensive headache with a lot of other fees involved.
  • Dealers make a ton of money on interest. If the financing comes from the dealer, they can easily mark up the interest rate by a small percentage that might seem insignificant to you, but it actually equals thousands more dollars in profit for them in the long run. In the industry, this is called dealer reserve, and it’s not cool.
  • Paying with cash is the best deal for you. Dealers don’t like when you pay for a car with cold, hard cash, because when you do, they don’t make as much profit. But it’s not your job to make them more money! Pay with cash and you’ll end up saving a lot more.
  • It’s better to be wealthy than look rich. Your boy is all about having nice stuff—but only if you can cash flow it and you’re more focused on the long term than the short term. If you’re at a point in your life where you want to be saving up for a house or your dream car, focus on that instead of getting sidetracked by a lease.

Buying a Car the Right Way 

You guys, don’t fall for all the hype out there. I want you to stay far, far away from leases or anything that causes you to sacrifice your long-term dreams and vision on the altar of your short-term desires. I said it before, and I’ll say it again: Paying for a used car with cash is always the way to go!

And just in case you think I’m preaching at you, let me just say that I’ve made my fair share of dumb car decisions too. One time I signed up for a car subscription program where I drove a different car every month. I spent $12,500 in one year on that when I could’ve been saving that money for my dream car. (Facepalm.) So, I’ve been there.

Stay focused, stay on track with your money goals, and start building real wealth for yourself and future generations. That, people, is how you win! For more tips on wealth building and leaving a legacy, plus plenty of tools that’ll help you do that, start a free trial of Ramsey+!

Anthony ONeal

About the author

Anthony ONeal

Anthony ONeal is a #1 national bestselling author, financial expert and host of the popular online series “The Table” on his YouTube channel. He has appeared on Good Morning America, the Tamron Hall Show, the Tom Joyner Morning Show and the Rachael Ray Show, among others. Since 2015, Anthony has served at Ramsey Solutions, where he teaches young adults how to budget, live without debt, avoid student loans and build real wealth for their future. Learn More.

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