A lease is like borrowing a car rather than buying it. You make monthly payments for the period of the lease, usually three to five years. At the end of the lease term, you have the choice of returning the car to the dealer, buying it, or in some cases, renting it from month to month. Even though you don't own the leased car, you're responsible for insurance and regular maintenance and repairs not covered by the warranty. You'll be required to keep detailed records of service and repairs and will probably be required to have all services performed at the dealership where you bought the car or another dealership of the same manufacturer. If you lease only for the length of the warranty, you'll never have to pay for major repairs.

When you lease, you're paying only for a portion of the car's value, the part you “use up,” known as depreciation. In a closed-end lease (a lease with a specific term), the price you'd pay to buy the car at the end of the lease is determined ahead of time. In an open-end lease, the car is priced at the end of the lease based on market value and the condition of the car.

The Benefits of Leasing

One of the major attractions of leases is the lower cost. They require relatively little cash up-front, usually $500 plus one month's payment as a security deposit and the first month's payment on the lease. Instead of the sales tax being paid up-front as it is in new-car loans, a portion of it is paid each month.

If sales tax in your state is 5 percent, the sales tax on a $20,000 car is $1,000. If you lease, that's $1,000 you don't have to borrow or cough up all at once. Leasing may be a good option for you in two situations: you like to have a new car every few years and don't want to incur the costs of buying and selling, or you don't have the money to come up with a down payment on a new car.

On the Other Hand

Leases may not be a good option for you if you put more than 12,000 to 15,000 miles per year on your vehicles. All leases include a mileage allowance, usually between 12,000 and 15,000 miles per year. If you exceed the allowance, you'll have to pay a fee at the end of the lease (often between ten and twenty cents per mile), which can add up to a significant amount of money. If your lease allows 12,000 miles per year and you average 14,000 per year for four years, the 8,000 extra miles at twenty cents per mile would cost you $1,600 in addition to your lease payments.

Understanding Leases

Leases can be confusing and most people enter into them without understanding how they work. As a result, they may end up paying far more than they should. Read all the fine print and ask questions to be sure you understand what you're getting into.

Leases have three basic components:

• Capitalized cost

• Residual value

• Interest rate or money factor

The capitalized cost is the price of the car. It's important to negotiate the lowest possible capitalized cost in order to reduce the size of your payments. Tell the salesperson that you want to negotiate the price of the car just as you would if you were buying it outright.

You have no direct control over the second component, the residual value, but you can influence it by choosing certain makes over others. Cars that depreciate quickly will cost you more to lease than those that hold their value. Remember, you're paying for the depreciation on the vehicle, so if you choose a car that depreciates quickly, it comes out of your pocket. A Toyota, for example, which retains more value than most American cars, would result in a lower lease cost than a Ford, everything else being equal.

The third component of a lease is the interest rate, which dealers aren't obligated to reveal to you. If the dealer won't tell you the interest rate, you can calculate it yourself. You should do so anyway just to be sure the salesperson is giving you an accurate rate.

How to Calculate the Interest Rate

To calculate the lease's interest rate, or money factor, go through the following steps. Don't be intimidated — this is easy with a calculator and pencil and paper.