How Car Leasing Works
When you lease a car you are simply paying for the amount that he car depreciates when you are using it. Depreciation means, the difference between the cars original value, and its value at the end of the lease, also known as the Residual value.
Different cars have very different depreciation rates. The best deals are cars that have the lowest depreciation. For example, if you find two different cars, both of them cost $35,000 new. After four years one is worth $25,000, and the other $20,000, because it is a smaller depreciation, the first car would be cheaper to lease.
To understand how leasing works, you need to know about MSRP, Residual value, Capitalized Cost Reduction, Money Factor, and lease term.
MSRP means Manufacturer’s Suggested Retail Price
MSRP is the full sticker price for the car. Even if Dealer fees are part of the total cost of the car, it is not considered part of the MSRP.
Capitalized Cost is also known as Cap cost. Cap cost is what you and the dealer come to an agreement on as the price for the leased car. The Cap Cost should be less than the MSRP. Don’t let the dealers fool you and tell you that you cannot negotiate the car price because it is a lease.
It is important to always lower the sticker price. The lower the Cap Cost, the lower your monthly lease payments are.
The Capitalized Cost will include certain fees. An acquisition fee is one of the fees added to the Capitalized cost. Acquisition fee is not generally shown in the lease contract. It is similar to a loan origination fee.
If you did not fully paid off your car when you trade it in, the Cap Cost will also include the remaining balance, after trade-in credit is applied.
Capitalized Cost Reduction
Capitalized Cost Reduction is when you reduce the price of the Cap Cost (lease cost). It could be reduced by down payments, rebates, and trade-in credit. Cap Cost Reduction equals lower monthly lease payments.
Adjustment Cap Cost is when you subtract the Cap Cost Reductions from the Cap Cost, it is also known as Net Cap Cost. There are a few formulas you could use to add up these figure. The formula comes later in the guide (monthly lease payments).
After deprecation, the wholesale value of the car is called the Residual value. The fact is that the higher the Residual value, the more your car is worth at the end of your lease. This also means lower monthly payments. Residuals are based on the resale history data of specific car makes and model. What leasing companies do is subscribe to services that provide this data, and then create their own Residual values.
Residuals are usually given as percentage of the MSRP. Therefore, if you lease for 24 months a $30,000 car, with a 40% residual, that means the estimated depreciated value of a 2-year lease is $18,000. The actual value may be less or more depending on the situation. The older a car gets, the less it is worth. In other words, Residual percentage decreases as the lease term (length of a lease) increases. Shorter lease are more expensive than longer lease, because Residuals decrease rapidly in the first year, then slow down in the later months.
24-month Residuals that are at least 50% of their original MSRP value are the best cars to lease.
The leasing company had to spend their money to buy the car from the dealer, so that they could lease the car to you. Just like a loan, they expect you to pay interest on that money. This interest is also known as Money Factor; sometimes it may be called a lease factor. It is described as a decimal number such as .00375. You can convert his decimal number into an annual interest rate, also known as APR, by multiplying it by 2400. For example, the Money Factor of .00397 multiplied by 2400 equals 9.53%.
Money Factor when converted to APR, should be close to, maybe even lower than a local new car loan APR. The lower your Money Factor, the lower your monthly payments are.
Because of the higher risk for the financial company, leasing credit requirements are stricter than for loans. If you have a perfect credit rating, you may get lower lease rates. If your credit is not so good, even if it was a mistake, your APR may be higher. We do advise you to check your credit score report and FICO score (www.freecreditreport.com), before going to your dealer. If you find any problems, get them resolved before you go to lease a car.
This is usually expressed in months. Lease term means the length of the time that you are leasing the car. The typical lease terms are usually 24,36, or 48 months, of course there are unusual terms such as 31, 40, 41 months. They have unusual terms to have your lease end at the time where they usually have a slow sales period.
It is sometimes smarter to have shorter lease terms, even though longer lease terms produce lower monthly payment. We say it is smarter because, if you lease a car longer than your car warranty, it will give you no security if something breaks on the car during your lease. Try to lease your car no longer than the warranty that comes with your car. 60-month lease are also not a good idea, unless you have a long warranty, because many of the major car problems start happening on the fourth or fifth year of the car.