How Leasing a Car (and Getting Out Early) Works

Laura answers a listener question about how to get out of a car lease early. Find out how leasing a car works, what to do if you need to exit one before it expires, and how leasing compares to buying a vehicle.

Laura Adams, MBA,
December 9, 2015
Episode #429

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How Leasing a Car (and Getting Out Early) WorksMoney Girl Podcast listener named Alexandra says, “I’m leasing a car that costs $425 per month and I have 22 months left before the lease expires. But this expense is taking a toll on my budget. I’m underwater and the dealer suggested getting a loan to purchase the car for $20,000. Is this the best option to get out of my car lease early?”

I’ll answer Alexandra’s important question and explain how leasing a car works. You’ll find out how it compares to buying and what to do if you need to get out of a car lease before it expires.

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What’s the Difference Between Buying and Leasing a Car?

Almost a third of all consumers choose car leasing instead of buying. I joined them this year when I leased my very first car: a 2015 Fiat e500. The “e” stands for electric and I’m also ecstatic about it because it’s really fun to drive and I never have to pump gas, just charge it at home or while I’m shopping.

First, I want to make sure you understand the fundamental difference between buying and leasing a car. When you get an auto loan you finance the purchase of a vehicle and with a lease you finance the use of one over a set period of time.

When you purchase a car with a loan, you finance the price of the vehicle less any down payment that you make. For instance, if you buy a $25,000 car and make a $5,000 down payment, you make up the difference by borrowing $20,000.

You can get a car loan from banks, credit unions, or local or online lenders, such as:

Your monthly payments are determined by the interest rate and length of the loan. Let’s say Alexandra borrows $20,000 at a 3% APR (annual percentage rate). If she gets a three-year loan, her monthly payment would be about $580.

That wouldn’t help her situation because it’s more than her current $425 lease payment. But if she got a 5-year loan instead, her payment would be close to $300, allowing her to save $125 per month.

While that lower payment sounds great, the longer your loan term, the more you pay in interest. Alexandra would pay almost $2,000 in interest over 5 years, while a 3-year loan would only cost about $940 in interest.

Plus, longer auto loans make it easier to get “upside down,” where you owe more than the vehicle is worth. That means if you want to sell the car or if it gets stolen or totaled in an accident, you might have to pay extra money out-of-pocket to make up the difference.

Some benefits of financing a car are that you can customize it, drive it as much as you want, and even drive it for years after you’ve paid it off. You can sell it or trade it in for its resale value at any time before or after you pay off the loan.

But the main downside is that you’re responsible for all major repairs after any warranty that you may have expires. While my example shows that Alexandra could potentially save money buying the car, she’ll be taking a risk that it won’t need any expensive repairs before it’s paid off. That could easily wipe out the savings she’s trying to achieve.

See also: 5 Ways to Get a Loan with Bad Credit


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