Leasing 101: What Goes into a Lease Payment?
When it’s time to finance a new car, you have two choices: a loan or a lease. Each offers advantages and disadvantages, and to figure out which method better serves your needs you have to know how each works.
Most car buyers understand the math behind traditional loan payments, but many don’t know exactly how lease payments are calculated. That’s important information to have in order to get the lowest monthly payments possible, and the dealer might not give you all the facts. Here are the basics of what you need to know.
Value of the Vehicle
The biggest factor in determining your monthly lease payment is the value of the car itself: The lower the value, the lower the payment. It’s important to realize that value is not the number on the window sticker — it’s the selling price you and the dealer agree to, the same as if you were purchasing the car. This fact often gets lost, in part because leases are usually advertised at a particular monthly rate, but leases are in fact negotiable,. In order to get the best possible selling price, you may want to negotiate the selling price with the dealer before revealing whether you want to lease or buy the car.
The biggest difference between a lease and a loan is how much of the car you’re paying for. With a loan, you’re buying the entire value of the car. With a lease, you’re paying only for the portion of the car you “use” during the lease term.
Here’s how it works. When you lease the car, the lease company estimates the car’s value at the end of the lease; this is called the residual value, and it’s stated in the lease itself. The difference between the selling price and the residual value is the estimated depreciation — this is the amount you pay for over the course of the lease. The lower the expected depreciation, the lower your monthly payments.
Where loans have interest rates, leases have what’s called the money factor. The terms refer to the same thing — the amount you pay for using the lender’s money — and money factor can be converted into a traditional interest rate simply by multiplying by 2,400. For example, if the money factor is 0.002, the equivalent interest rate is 4.8 percent. This will give you an important financial comparison to a loan the dealer or your bank is offering; you don’t want to be lulled into paying a higher interest rate for a lease even though the monthly payments are lower.
The dealer won’t necessarily tell you the money factor, however, because, unlike an interest rate, there is no law that specifies it must be revealed. Instead, you might need to calculate it yourself based on the lease’s “lease charge” or “rent charge,” which is the total finance charge over the full length of the lease. You can find instructions on how to do this calculation online.
Equity of Trade In
When it’s time to get a new car, most of us get rid of our old car, either by selling it or by trading it in at the dealer. (If you’re currently leasing a car, there’s a third choice: Simply return it to the dealer and walk away.) If your old car is worth more than you owe on it, you have positive equity, which you can apply toward the cost of a new car you want to lease.
If your old car is worth less than you owe it, you have negative equity, and must make up the difference in order to trade in the car. This is not an uncommon scenario, especially if you bought the car but have only owned it for a couple of years, and dealers will often fold that negative equity into your new lease. This will raise the monthly payments on your new car, but it’s a good option to have if you don’t have the money to cover the negative equity outright.
As with a mortgage on a house, a down payment for a lease is simply cash paid up front as part of the contract. Down payments are mandatory on some leases, optional on others, and some tout no down payment at all in order to make the car less expensive up front (although the monthly payments will then be higher). The advantages of making an optional downpayment, or a larger mandatory one, are that your monthly payments will be lower and you’ll be paying less in finance charges.
In addition to a possible down payment, a number of fees will be charged at the start of a lease. These include the local and state fees for registration, license plate, and title, as well as the dealer’s documentation fee. These are typical costs also associated with a purchase, as are, depending on where you live, sales and/or property taxes charged on some portion of the selling price.
There are a few fees unique to leasing. One is the acquisition fee, which covers the cost of arranging the lease itself, and is paid up front. Some leases also require an up-front security deposit, which will be used to pay for any necessary repairs when you return the car. At the end of the lease, you’ll likely have to pay a disposition fee, which covers the dealer’s cost of reselling the leased vehicle. Some manufacturers don’t charge a disposition fee at all, and you certainly shouldn’t be charged one if you buy the car at the end of the lease.
With this information, you have the tools to understand where the lease price your dealer offers you comes from, which will help you decide if a lease is the best financial choice for you. Just don’t forget to negotiate that selling price!