Understanding the Basics of Car Leasing: Key Factors You Need to Know

When it comes to understanding the basics of car leasing, there are several moving parts to consider (pun intended!). While leasing can be a great way to get into a new vehicle with lower monthly payments, it’s important to know what you’re paying for—and how much.

In this guide, we’ll dive into key lease components, like the money factor, residual value, depreciation, and the $7,500 EV credit. Finally, we’ll compare leasing to buying so you can decide which option works best for you.

Key Takeaways

• Leasing lowers monthly payments but doesn’t build equity like buying.
• The money factor is your lease’s interest rate—multiply it by 2,400 to get the APR.
• EV leases might qualify for a $7,500 tax credit at the point of sale, reducing costs.
• Leasing offers flexibility to upgrade to newer EV technology with a short-term commitment.

Money Down: How Much Should You Put Toward a Lease?

One of the first decisions you’ll need to make when leasing a car is how much money to put down at signing. Unlike financing a car purchase, where a down payment reduces your loan balance, a lease down payment (often called “capitalized cost reduction”) lowers your monthly payments by reducing the amount you finance.

However, keep in mind that putting more money down does not always make sense with leasing. You’re essentially prepaying a portion of your lease, which won’t benefit you if the car is totaled or stolen. For most leases, dealers offer flexibility, so balancing between reducing monthly payments and preserving cash flow is key.

Money Factor: Unmasking the Hidden Interest Rate in Leasing

The “money factor” is the hidden equivalent of an interest rate in a lease. Most consumers aren’t aware of it, but it’s a critical piece that determines how much you’re paying to lease the car. You can typically find the money factor listed in your lease agreement as a small decimal, like 0.00125. To convert it to an equivalent APR, multiply it by 2,400.

For example, a money factor of 0.00125 translates to an interest rate of 3%. Always ask the dealer for the money factor and use this conversion to understand what interest you’re effectively paying on your lease.

Residual Value and Depreciation: How They Shape Your Monthly Payments

When you lease, you’re essentially paying for the depreciation of the vehicle during the term of your lease. The “residual value” is the estimated value of the car at the end of your lease. A higher residual value results in lower monthly payments, as the car retains more of its value. Conversely, a lower residual value means higher payments because the car depreciates faster.

Residual value is typically set by the leasing company and is non-negotiable. However, it can vary across brands and models, so it’s important to consider when choosing which car to lease.

At the end of your lease, you usually have the option to purchase the car for its residual value, if you want to keep it. This option can be appealing if you love the car and feel it’s a good deal at that price. (Note: Some manufacturers, like Tesla, have limited or eliminated the option to buy the car at lease-end. Always check the specific terms of your lease.)

EV Leasing Incentive: The $7,500 Federal Credit at Point of Sale

One of the major benefits of leasing an electric vehicle (EV) is the availability of a $7,500 federal tax credit, which can be applied directly to the lease at the point of sale. This credit effectively reduces the capitalized cost of the lease, leading to lower monthly payments.

Unlike purchasing an EV, where the $7,500 tax credit depends on your income, the leasing incentive is not subject to those restrictions. It applies directly to the lease as long as the vehicle qualifies, and you don’t have to worry about tax filings later to claim it. This makes EV leasing an attractive option for many consumers.

Furthermore, when you purchase an EV, not only do you have to meet the income requirements for a vehicle to qualify for the $7,500 tax credit, the vehicle must:

• Have a battery capacity of at least 7 kWh.
• Have a gross weight rating of less than 14,000 pounds.
• Be made by a qualified manufacturer and its final assembly must be in North America, following the Inflation Reduction Act (IRA) rules.
• Meet critical mineral and battery component requirements.
• Not exceed price caps, which range from $55,000 (for sedans) to $80,000 (for SUVs, trucks, and vans).

However, there’s a loophole in the law that allows you to bypass these requirements by leasing. Under the Inflation Reduction Act, leasing is classified as a commercial sale. When you lease, the automaker technically sells the vehicle to a leasing partner, who then handles the transaction with consumers.

The U.S. Treasury Department grants the tax credit to the leasing partner, who can then choose to pass the savings on to the lessee. It’s important to check with the dealership or leasing company to confirm that the $7,500 credit will be applied and how it will be reflected in your lease payments.

Additionally, leasing an EV can make sense for those looking to experience the latest advancements in electric vehicles without a long-term commitment. EV technology—such as battery range and self-driving features—is improving rapidly. Leasing lets you enjoy the benefits of an EV now while keeping your options open to upgrade to a newer model as technology advances.

Taxes and Fees: Don’t Forget Sales Tax

Yes, you still have to pay sales tax when leasing a car, just like when purchasing one. However, instead of paying it upfront on the full purchase price, you typically pay sales tax only on your monthly lease payments, which spreads out the cost.

In some states, sales tax on the down payment or capitalized cost reduction may also apply, so it’s important to understand how taxes are calculated where you live. Additionally, keep an eye out for other fees like acquisition fees, documentation fees, and any potential early termination fees if you decide to end your lease early.

Leasing vs. Buying: What’s Right for You?

Finally, let’s break down the pros and cons of leasing versus buying:

• Leasing Pros:
  • Lower monthly payments compared to buying.
  • Always drive a new or nearly new vehicle.
  • Maintenance is often covered by warranty.
  • EV leasing might offer instant savings with the $7,500 credit.
  • Short-term commitment is great for trying out rapidly evolving EV technology.
• Leasing Cons:
  • You don’t own the car at the end of the lease unless you choose to buy it for the residual value.
  • Limited mileage and penalties for going over the limit.
  • Extra costs for wear and tear.
  • More expensive long-term if you keep leasing repeatedly.
• Buying Pros:
  • Full ownership—once the car is paid off, you have no more payments.
  • No mileage restrictions.
  • Can customize the vehicle however you like.
  • Tax benefits (such as deducting interest) if the car is for business.
• Buying Cons:
  • Higher monthly payments and/or longer loan terms.
  • Depreciation means the car loses value quickly.
  • Maintenance costs after the warranty expires.
  • EV tax credits for purchasing depend on your income.

Both options have their merits, so the choice largely depends on your financial goals and driving habits. If you prefer flexibility and lower monthly payments, leasing might be the way to go. If long-term ownership and building equity in the vehicle are important to you, buying may be the better choice.