Component 1: Capitalized Cost

The capitalized cost is nothing more than the final selling price of the vehicle that you’ve negotiated with the dealer. This is inclusive of any dealer fees, back end profit items the finance and insurance manager has tried his best to tack on, remaining amounts owed on a previous vehicle you’re rolling into the new contract, acquisition fees, etc. For this, we recommend you refer to the other sections of this site that pertain to a vehicle purchase, because you’ll be treating the negotiations of your lease’s capitalized cost in exactly the same manner as you would had you been buying the vehicle. Once the final sale price is agreed upon, you may certainly opt to make a down payment, or use rebate money to lower your monthly payments. In leasing, any monies paid up front are referred to as a capitalized cost reduction and are to leasing what a down payment is to a purchase.

Always remember that in a lease, it is the leasing company (the lesser) who is buying the vehicle from the dealership. The leasing company will buy the vehicle you’ve selected from the dealer’s inventory at the exact final selling price (capitalized cost) you have negotiated as low as possible. Remember, the lower you get the capitalized cost, the lower your monthly payments will be.

Because the capitalized cost is to leasing what the final sales price is to purchasing, getting dealer invoice pricing data, holdback numbers, and hidden factory to dealer rebates and incentive information for the particular vehicle you’re leasing is crucial to avoid being in the unsettling position of blindly negotiating the capitalized cost. One of the best reports we’ve seen offering this information is from CarDeals, a subsidiary of Fighting Chance and well worth the time that it takes to secure it, as this will be invaluable information to have with you in the showroom when you’re trying to get your capitalized cost as low as possible.

Component 2: Lease Term

This is the length of your lease in months, as well as the number of payments that you will be making. Obviously, a longer lease term means lower monthly payments, with one caveat being that it’s usually not a good idea to be in a situation where your lease term is greater than the warranty period on the vehicle.

Component 3: Residual Value

The residual value is a figure that is set by the leasing company at lease inception for what it believes the market value of the vehicle will be at the end of the lease term specified in your contract when you either turn the vehicle in or elect to purchase it. This is a value which is being forecasted several years into the future, based on the term you’ve selected, and may prove accurate or not. In a closed-end lease (the only type that you want to enter into), it is of no real concern or exposure to you, whether the residual value set at lease inception proves to be higher or lower than what the actual market value of the vehicle proves to be at that given point in time. Do remember (as we illustrate in the chart below) that while you have little or no control over what this number is, you do want it to be as high as possible. This is because the function of the residual value is to create a spread between itself and the capitalized cost, which will represent the depreciation amount which you will be paying for. This is illustrated in more detail below.

Keep in mind that residual values are usually expressed as a percentage of the vehicle’s MSRP and then later translated into a dollar figure for purposes of figuring the numbers involved in your lease. For example, if a vehicle has an MSRP of $32,000 the residual value being assigned to it by a particular leasing company might be represented as 54%. This means that 54% of the vehicle’s original $32,000 value would still remain at lease end. As a dollar figure, the residual value in this example would be $17,280 ($32,000 x .54 = $17,280).

As a lessee, you don’t have a say in determining the residual value. What you do have is the ability to compare the residual values of different leasing companies and (all other things being equal) give your business to the institution offering the best residual figure. In other words, don’t get bulldozed into a feeling like you’re locked into having to accept the first leasing company the dealer wants to place you with, especially since the dealer may have selected that company based more upon how much money they’ll make placing you, rather than for it being the company with the best terms for you. The problem is that in general you won’t know what a competitive residual value would be, nor will the dealer usually volunteer that competing leasing companies have differing residual values for the same model and lease period. Therefore, once you know the model you would like to lease, we highly recommend securing information on what current competitive vehicle residual values are from sources such as Expert Lease Pro, a licensee of Black Book residual values that it provides for 12, 24, 36, 48 and 60 months. This is money well spent in our opinion, in that it could save you from being put into a lease with a lower than prevailing residual value.

Component 4: Lease Fee

Leasing companies are far from being philanthropic organizations that solely existing to assist you in your pursuit of driving bliss, and like all other financial institutions their purpose is to realize a profit. One of the ways they accomplish this is by charging you a fee for their having laid out the money to buy the vehicle you’ll be leasing from them. You may also see this fee referred to as lease charge or rent charge on a lease contract.

The lease fee is figured by something called a money factor and just like its APR counterpart in a vehicle purchase, the lower the money rate is, the lower your monthly payment will be. The money factor looks a little different though because it’s expressed as a decimal figure, such as .0028 or .0032 etc. Just remember that it can easily be converted into a comparable APR rate by multiplying by 2400. For example, a .0028 money factor would compute to a fairly accurate 6.72% APR and a money factor of .0032 calculates to an approximate APR of 7.68%. This calculation also works in reverse should you find yourself in a situation where you have the APR and need to work it backwards to get the proper equivalent money factor when you run the numbers. To do this, simply divide the APR by 24 to closely arrive at the money factor that should be used. For example, taking the same 6.72% APR above and using this formula (.0672 / 24 = .0028) quickly gives you the money factor. This is useful in the common situation where the money factor is not disclosed in the lease contract (read more about nondisclosure below) and you’ve asked the dealer for the comparable APR and you of course want to keep him honest by running the lease numbers once you have them all. This way you’ll know if it was the true APR equivalent, or just one the salesperson thought would sound good to you!

The lease rate (and money factor used to compute it) is an area you need to be extra vigilant in making sure the dealership is not taking advantage of you for two major reasons.

First, just as dealers make money on “placing” your finance business with a lending institution on a purchase transaction (see “dealer reserve” in the financing section), the same practice exists with leases. Leasing companies competing for your business offer attractive commissions to the dealership for writing your lease through their company. The way this happens is by the leasing company authorizing the dealership to quite literally apply an inflated money factor to your contract that can yield hundreds of dollars above and beyond the amount you should have paid had you been wise to this practice. This is exactly why the dealership will try very hard to not provide you with the money factor if they are in a state which does not require them to (more on this below). To thwart getting caught up in this practice, especially when the rate is not being disclosed, you first need to make certain that you test the money factor against prevailing annual percentage rates, or vice versa, as outlined above. Prior to setting out for the dealership, you need to secure your credit score information from providers such as www.freecreditreport.com or www.myficoscore.com, so that you’ll know the APR you should be qualifying for and can object when the dealer tries to introduce one into the mix that is substantially higher.

Secondly, to complicate matters further as we alluded to above, many states do not require that the money factor appear in your lease contract. As utterly ridiculous as this sounds, it’s true, and because this is frequently the case you need to ask the dealer what the money factor being used is. This may or may not be straight forward to accomplish, as we have come up against much resistance in our experience, once having even been told straight out by a dealership controller that his sales staff specifically will not disclose the money factor - even when asked! In our opinion, we think you should bring your business elsewhere if you run up against a dealer that is this secretive and questionable in their sales practices as to be bold enough to refuse providing you with one of the biggest components that will determine your lease payment. If unlike us you still wish to give them your business, it is possible to work the other lease component numbers you will ultimately have backwards to uncover the money factor and equivalent APR which is being used in your contract and we’ve included such a scenario in our lease examples below. The rule of thumb at the dealership is to be certain to run all the numbers as we’ve shown you below prior to signing any paperwork. It may be shocking to uncover just how much extra money the dealer has tried to get out of you, thinking you were just another run of the mill uneducated leaser!

~ How the Money Factor is Applied in Determining the Lease Fee Portion of Your Monthly Payment ~

Once you’ve cut through all the nonsense we’ve spoken of above and know the money factor, the next thing to understand is how it’s applied in figuring the lease fee portion of your payment. Almost all leasing companies (with the exception of Ford’s) will take the capitalized cost figure and add it to the residual value figure, then multiply that resulting number by the money factor. For example, a capitalized cost of $20,000 and a residual value of $9,500 would be added together to get $29,500 which is then multiplied by the money factor (which for our example we’ll say is .0028). The result is $82.60 ($29,500 x .0028 = $82.60) being added to your monthly payment, attributable to the leasing company’s fee or rent charge. Remember that this is only 1 of 2 portions that make up your monthly payment – the other is the depreciation portion and we’ll look at how that gets calculated in the examples below.