How Does A Lease Agreement Work?

Real Estate Lease Contract and pen close up

Leasing, also known as renting to own, provides a low cost way of entering the housing or car market. The difference between leasing and normal renting is that leasing generally implies that ownership is expected to occur eventually, and a lease agreement covers exactly how and when this transfer of ownership occurs. Understanding the advantages and disadvantages of leasing is best illustrated by way of comparison. This article uses the example of purchasing versus leasing a car, but similar examples exist for homes.

Buying a car

When purchasing a vehicle, most individuals need a loan or financing to buy the car. Not many people can afford many thousands of dollars up front! A car dealer often offers a financing arrangement. The purchaser pays a down payment, usually around 5 to 20 percent of the car's sticker price, with the rest being paid off as a loan. The purchaser then makes payments every month to settle the loan. In this arrangement, the buyer rolls off the lot owning 5 to 20 percent of the car, and buys the rest incrementally over the next several years.

Leasing a car

When leasing a car, the payment schedule is broadly reversed. The buyer rents the car a month at a time for an agreed upon term, usually about two years. At the end of the term, the buyer has the option of purchasing the rest of the car outright for a reduced price, or returning the car and beginning to rent a new vehicle. Compared to purchasing the vehicle upfront, the buyer rolls off the lot owning 0 percent of the car, but then towards the end of the schedule he or she buys the remaining 40 percent in one lump sum. The down payment comes at the end!

Consider leasing carefully; leases involve less money up front but more in the long run, so while saving for a down payment is aggravating, it ultimately saves money.

A lease has several attractive features. The buyer can rent a car without the need for a large down payment. He or she can choose whether or not to purchase it at some point in the future depending on how the car performs. Also, the buyer has the option of driving a new car every couple of years if he or she forgoes ownership. The downside of leasing is cost; whether one continues renting or actually buys the car, he or she ends up paying more per day driving than if an outright purchase was financed. About 80 percent of purchases are done with traditional financing for this reason, while the remaining 20 percent are carried out as leases.

Leases involve less money up front but more in the long run