Even if you hate math, you owe it to yourself to become intimately familiar with the
method of calculating and analyzing monthly lease payments. The ability to understand
and manipulate the numbers that make up your lease quote may be the most powerful tool
in your bargaining arsenal. After all, you will never know if you have truly obtained the best
deal possible if you know nothing about how the dealer arrived at the monthly payment he
quoted. In this arena, knowledge is cash. If you just refuse to get down and dirty with
numbers directly, a software program like LeaseWizard® can do the calculations for you
and recommend ways to improve your deal (See Appendix A). Whichever method of
calculation you choose, become acquainted with the four basic components of all vehicle
lease payments.
The Four Basics of a Lease Payment
In order to analyze any lease payment, you must know the following four elements:
to lease signing. The trick is to ask for the disclosures well before you sit down to sign the
lease. Bring the dealer’s disclosure sheet home and crank through the numbers to
determine whether the offer proposed is satisfactory to you and whether he gave you all of
the terms you thought you had bargained for during your visit. (LeaseWizard® Software
allows you to print disclosure forms before you visit the dealer). Let's explore each element
in detail.
Adjusted Capitalized Cost
The beginning point in the calculation of any lease payment is the capitalized cost
(or cap cost). The cap cost is equivalent to the negotiated "purchase price" of the vehicle.
Its name comes from the fact that this amount will be “capitalized” or accrue interest over
the lease term. The cap cost includes the agreed upon price of your vehicle1 as well as
any charges you wish to "roll into" your lease payment, such as acquisition fees, sales
and luxury taxes2, credit life insurance, extended service warranties, gap insurance
premiums, advertising costs, dealer preparation fees and destination fees. If you are
trading in a vehicle for which you owe money, that amount may also be lumped into the
capitalized cost for you to finance going forward under your new lease. The dealer will
reduce the cap cost by the amount of any down payment, trade in allowance, or
consumer rebate. These adjustments are called cap cost reductions. After all
adjustments are made, the final cap cost is referred to as the adjusted cap cost. The
adjusted cap cost is analogous to the amount financed in a purchase contract.
To get an idea of what your initial cap cost should be, consult a printed pricing guide
(in bookstores) or hop on the Internet and go to KBB.com or Edmunds.com to obtain
“dealer invoice” and option prices. Even armed with “invoice” pricing, however, you will still
need to do a little homework to find a fair and appropriate price. Popular vehicles that are
low in supply may even fetch more than MSRP. To get a good idea what the market will
bear, try the “Live Quote” feature included in LeaseWizard® Software.
Residual Value
The residual value of a leased vehicle is the lessor's estimate of what the vehicle will
be worth at the end of your lease term. Sometimes referred to as the lease-end value, the
residual value is an important number to know for a couple of reasons. Your monthly lease
payment is based on the difference between the adjusted capitalized cost and the residual
value of the vehicle (we will discuss this fully in Chapter Three - Assembling the Pieces).
For that reason, knowing your residual value is essential in determining your repayment
liability. In addition, the residual value represents the minimum you should expect to pay if
you elect to exercise your purchase option at lease end (in a closed end lease). In an
open-end lease, the residual value takes on even greater importance.
Residual values are usually figured as a percentage of the vehicle’s MSRP. For
example, a $25,000 MSRP and a 50% residual factor will result in an estimated $12,500
residual value at lease end. You can get a pretty good idea of what the industry thinks the
residual value of your vehicle should be by consulting the industry-standard Automotive
Lease Guide.3 The ALG residual value on a vehicle represents what a reconditioned clean
vehicle should fetch at auction. That’s right, it’s wholesale, not retail. ALG values typically
represent the conservative end of the spectrum. At the other end of the residual rainbow
usually reside captive finance companies, which inflate projected residuals in order to
deliver lease incentives akin to rebates on vehicle purchases.
Residual values will vary depending upon the particular model you choose, the lessor (i.e. bank, captive finance company or independent leasing company), the amount of miles you anticipate driving, and particular promotions being offered on that model. In all cases, the lessor -- not the dealer -- sets the residual value (although some dealers have been known to shave the residual to earn more money on the deal). So, the best you can do is shop among different lessors for the most competitive number. You can expect variations among values offered by the captive finance companies, independent leasing companies, and banks. One way to shop residuals is to simply quiz the dealer’s finance manager to find out which lenders are offering aggressive residual values along with competitive rates. Before you get to the dealer, however, I recommend visiting LeaseWizard® Software for ALG and market residual values on virtually all makes and models sold in the United States. When shopping residuals, be sure to research similar type vehicles made by different manufacturers to take advantage of unusually high residual values being offered to aggressively promote certain models.
Those looking to enter into a closed end lease (most consumers), should shop for the highest residual value possible because the higher the residual value, the lower the monthly payment will be, all other things being equal. This occurs because the residual
value is subtracted from the adjusted cap cost to arrive at the amount you must repay over
the lease term.
Example 2.1
Low Residual: 18,000 - 9,000 = $9,000 (amount to repay)
Adj. Cap. Cost Residual
Higher Residual: 18,000 - 10,000 = $8,000 (amount to repay)
Adj. Cap. Cost Residual
Believe it or not, there are times when you might not wish to have a high residual value. If you are planning to enter into an open-end lease, for example, you will be safer with a less aggressive residual value. In an open-end lease, you are liable for the difference between the predicted residual value and the actual amount received by the lessor on the sale or auction of your vehicle at lease end. If the open-end residual value is artificially inflated to reduce the monthly payments, the shark will show up at lease end when the actual market value of the vehicle is lower and you owe the difference. If you are seriously considering a lease-end purchase, you may also be a candidate for a lower residual value because that is typically the amount you will be expected to pay for the vehicle. Of course, you must balance that possible saving against higher monthly payments.5 A low residual value also makes good sense if you are leasing a vehicle for business purposes and you have the opportunity to purchase it for personal use at lease end. Provided the vehicle is actually being used for business, the higher monthly payments may be deducted as a business expense during the course of the lease. Unless you fit into one of those categories, however, you will likely find yourself shopping for a high residual value in order to obtain the lowest monthly payment. Manufacturers are aware of this and often "push" the residual value in order to advertise and deliver lower monthly
payments. This usually operates to your benefit. TIP: High residual values offered by captive finance companies are often accompanied by low money factors. Shop, look and listen for this compelling combination!
Rent Charge
For reasons not apparent to most folks, the term "interest" or “APR” is absent from lease documents and, seemingly, from the vocabularies of most people in the vehicle leasing business as well. Instead, you will find terms such as rent charge, lease charge, lease factor or money factor. In their purest form, these charges all reflect the same thing - the cost of money! Why the fancy terms instead of interest which most everyone understands? There is actually a good reason for this. Technically and legally speaking, you are not borrowing money under a lease so “interest” is not really being charged. In fact, federal regulations will effectively prohibit the use of typical loan-interest terminology in leases. Behind the technical reason is a substantive disclosure issue. The reason a single rate cannot be applied to leases like an APR is used in loans stems from the inherent variability in leases from one consumer to the next. What does that mean? In plain terms, it means that certain items in a lease that affect the rate of return the lessor is receiving vary among individuals, and, therefore, cannot be uniformly applied to all leases. A lessee who returns his vehicle at lease end, for example, will generate one rate of return for the lessor while a different lessee of the exact same vehicle will generate another if he exercises the purchase option. In addition to problems in calculating a uniform rate, there are serious disclosure problems with a uniform lease rate.
One of the most interesting pitfalls is called “The Residual Loop”. A company named Bank Lease Consultants brought this phenomenon to the attention of the Federal Reserve Board during the formation of Regulation M in the late 1990’s. BLC showed that, if permitted, a lessor could confuse consumers by advertising a lower rate than his competitor and still charge exactly the same monthly payment on the same vehicle, simply by manipulating the residual value. Requiring a uniform rate disclosure would have allowed unscrupulous lessors to easily lure unwary consumers into more expensive leases by manipulating the residual value and then advertising extremely low “rates.” Suffice it to say that the absence of typical loan interest terms is not just a trick to make leasing more difficult for consumers - it’s a protection.
So how do we research and compare the cost of money under a lease? The most common way is through total or average monthly rent charges. The rent charge (commonly referred to as a lease charge) is comprised of a rate of
return on the lessor’s money as well as other costs of business such as gap insurance premiums, residual value guaranty insurance, vicarious liability insurance7, and fraud, skip and credit loss insurance. Federal law requires that the total rent charge be disclosed to consumers before they sign a qualifying lease. With the total rent charge, one can easily determine how much money they are paying each month for interest and the lessor's profit. Now, if you’ve had any experience with leasing, you are probably champing at the bit for me to explain where the money factor fits into the mix.
The Facts About Money Factors
Money factors are rate expressions used to calculate the average monthly rent charge. They typically appear as four or five digit figures preceded by a decimal point and look nothing like ordinary interest rates which are expressed in annual percentages (i.e. .0035 or .00312).8 If you are comfortable with numbers, try to obtain the money factor because it will be easier for you to run “what-if” scenarios and compare it to factors offered on other leases. Since the dealer or lessor can only give you a rent charge after calculating the entire lease (with residual, cap cost etc… already figured), you have much more flexibility with the money factor. With it, you can figure out the monthly rent charge and, with minimal manipulation, convert it into a number that approximates an annual money factor (i.e. .0000035 or 3.5 instead of .0035). If you see something like this, you can easily convert it by
moving the decimal point a few places. Some companies, like GMAC, Chrysler and Ford Motor Credit, either do
not use money factors or else have factors that do not even remotely look like those used by the majority of players in the industry.
Warning: Before attempting to convert your money factor into an approximate annual interest rate, be sure the number you have been given is actually a money factor and not an approximate annual percentage rate. For example, if you were told “two-nine” by the dealer you might not know whether the rate being charged was 2.9% or a .0029 money factor (which is approximately equal to 6.9%). The two are quite different. For this calculation, make sure you have a money factor! Sometimes referred to as a “lease factor” or “level yield factor,” the money factor is
simply a multiplier. It is not a rate! If you want to mess with the money factor, be sure you fully understand how the lessor uses it or you risk misunderstanding your deal. Money factors can vary from lessor to lessor. For example, one lessor may use a money factor of .0034 and calculate your average monthly interest multiplying that number by the sum of the adjusted cap cost and residual value. That would be typical (we will explore the math later). Consider, however, what would happen if the lessor’s formula took a conventional money factor, cut it in half (to .0017) and simply multiplied it by two before doing the other multiplication described above? That lessor could legitimately tell you he’s using a .0017 factor. But you would be comparing apples to oranges if you equated it with typical factors used by other lessors. Worse, your calculations would be off twofold if you did not know to multiply their factor by two before beginning your calculations.
If you are comfortable dealing with money factors, you should be able to get one from the dealer and crank through the numbers yourself. Assuming you get what you’re looking for, you should have no problem calculating average monthly rent charges or converting them into approximate annual rates for comparison purposes.
Unless you run a full-blown internal rate of return analysis, you’re unlikely to stumble upon the exact APR rate being charged under your lease. Fortunately, automobile leasing is not nuclear physics where infinitely precise numbers are always needed. For the vast majority of consumers, a close approximation will do fine for comparing deals.
Power Up Your Calculator!
Assuming the dealer gives you a conventional money factor of .0035 and you wish
to know the approximate annual rate, first multiply the money factor by 2400 as shown.
Example 2:2
.0035 x 2400 = 8.40% Approximate Annual Rate10
As a rule of thumb to enhance the accuracy of your calculation, you can add .07 (7 basis
points) to the result for every year the lease term is less than 36 months. In our example
above, the approximate annual rate on a 24-month lease would be:
Example 2:3
8.4% + .07% = 8.47% Approximate Annual Rate
Note: The approximate annual rate yielded by this calculation is essentially the lessor’s
rate of return. If there is an acquisition fee, the lessor’s rate of return will be higher.
If the dealer quotes you an annual rate (which he should not really do), but uses a
money factor in the calculations, you can cross-check the quoted rate by simply reversing
the equation and dividing the money factor by 2400 as shown.
Example 2:4
8.4% Annual Rate = .0035 Money Factor
Actually, multiplying by 24 will give you .084 the correct representation of 8.4%. Using 2400, however,
dispenses with the need to move any decimals - just add a “%” sign and you have it!
Monthly or Total Rent Charges
In your contract, the cost of money should be expressed as a total (and perhaps an average monthly) rent charge, rather than as an annual interest rate or money factor. For example, the dealer may disclose total rent charges of $5,000 on a 48-month lease. You can derive the money factor and a resulting approximation of the annual interest rate by performing the following calculations:
First, convert the total rent charge into an average monthly rent charge by dividing it by the term of the lease.
Example 2:5
$5,000 = $104.17 average monthly rent charge over 48 mos.
The resulting figure ($104.17 here) is the portion of your monthly payment, on average,
that represents the cost of money. Next, derive the money factor by dividing the $104.17
rent charge by the sum of the adjusted cap cost and the residual value. In our example, if
the adjusted cap cost is $18,000 and the residual value is $8,700, the money factor can be
calculated as follows:
Example 2:5
$104.17 (monthly charge) = .0039
$26,700 ($18,000 + $8,700)
Adj. Cap + Residual
If you want to know the approximate annual rate, simply multiply the money factor by 2400
as described in the previous section and you get:
Example 2:6
.0039 x 2400 = 9.36% Annual Rate
Did you notice how a mere difference of only .0004 from the .0035 money factor in Example 2:3, and the .0039 money factor from Example 2:5 resulted in nearly a full percentage point increase in the approximate annual rate of interest?!
Historically, dealers have referred to the rent charge as a “lease charge.” Although Regulation M encourages the
use of the term “rent charge,” you may hear the term “lease charge” until the industry catches up.
TIP: Keep in mind that the money factor or rent charge is only one measure of comparison among leases and you should not rely upon it exclusively when comparing two or more leases. Compare all aspects of your lease offers!
Lease Term
Although a longer lease term yields a lower monthly payment, generally be wary of lengthy leases. As with a loan, the longer the lease term, the more you will pay in interest charges. In addition, the longer the term, the more likely it is you will have to make major repairs to a vehicle you do not own. For that reason, I recommend that the term of your lease not exceed the life of the warranties covering your vehicle. If your budget forces you to consider only leases with terms exceeding the vehicle warranty, you are usually better off looking at a less expensive vehicle. Another view on this issue held by at least one esteemed leasing expert is that the cost of repairs should be considered separately from the issue of how you intend to finance the vehicle (i.e. lease or buy). According to that
view, you risk paying for repairs regardless of whether you lease or buy because you are obligated to return the leased vehicle in good working condition and with only ordinary wear and tear -- presumably the same way you would treat the vehicle had you bought it. In my view, one of the primary benefits of leasing is the ability to push the risk of repair over to the lessor by leasing for a term that is less than the length of the warranty. If, on the other
hand, you lease with the intention of exercising the purchase option, you probably do not need to treat the repair issue any differently than you would in a purchase situation. Another factor you should consider is that statistically, most people do not stay in their 48-60 month leases for the full term. That means they are terminating their leases
early and usually paying a premium to do so. To add insult to injury, the rates offered on longer term leases are typically not as aggressive as those accompanying 24-42 month leases. Unless you know you will exercise your purchase option, choose a shorter lease.
If you insist on entering a longer-term lease to obtain the lower monthly payments, at least look for a vehicle that ranks high in its ability retain value. Better cars will fare better on early termination where you receive credit for the actual or estimated wholesale auction price of your vehicle. Keep in mind, however, that leases are designed to permit you to pay in as little as possible in order to get you to zero equity by the time your lease expires. Generally, you can expect to be "upside down" (in other words, you will owe more than the car is worth) on your lease until you have reached the end of your term. If you terminate early and “roll into a new lease,” prepare to have the negative equity rolled into your new lease, making the payments higher than they should be for the new vehicle.
method of calculating and analyzing monthly lease payments. The ability to understand
and manipulate the numbers that make up your lease quote may be the most powerful tool
in your bargaining arsenal. After all, you will never know if you have truly obtained the best
deal possible if you know nothing about how the dealer arrived at the monthly payment he
quoted. In this arena, knowledge is cash. If you just refuse to get down and dirty with
numbers directly, a software program like LeaseWizard® can do the calculations for you
and recommend ways to improve your deal (See Appendix A). Whichever method of
calculation you choose, become acquainted with the four basic components of all vehicle
lease payments.
The Four Basics of a Lease Payment
In order to analyze any lease payment, you must know the following four elements:
- Adjusted Capitalized Cost
- Residual Value
- Rent Charge or Money Factor
- Lease Term
to lease signing. The trick is to ask for the disclosures well before you sit down to sign the
lease. Bring the dealer’s disclosure sheet home and crank through the numbers to
determine whether the offer proposed is satisfactory to you and whether he gave you all of
the terms you thought you had bargained for during your visit. (LeaseWizard® Software
allows you to print disclosure forms before you visit the dealer). Let's explore each element
in detail.
Adjusted Capitalized Cost
The beginning point in the calculation of any lease payment is the capitalized cost
(or cap cost). The cap cost is equivalent to the negotiated "purchase price" of the vehicle.
Its name comes from the fact that this amount will be “capitalized” or accrue interest over
the lease term. The cap cost includes the agreed upon price of your vehicle1 as well as
any charges you wish to "roll into" your lease payment, such as acquisition fees, sales
and luxury taxes2, credit life insurance, extended service warranties, gap insurance
premiums, advertising costs, dealer preparation fees and destination fees. If you are
trading in a vehicle for which you owe money, that amount may also be lumped into the
capitalized cost for you to finance going forward under your new lease. The dealer will
reduce the cap cost by the amount of any down payment, trade in allowance, or
consumer rebate. These adjustments are called cap cost reductions. After all
adjustments are made, the final cap cost is referred to as the adjusted cap cost. The
adjusted cap cost is analogous to the amount financed in a purchase contract.
To get an idea of what your initial cap cost should be, consult a printed pricing guide
(in bookstores) or hop on the Internet and go to KBB.com or Edmunds.com to obtain
“dealer invoice” and option prices. Even armed with “invoice” pricing, however, you will still
need to do a little homework to find a fair and appropriate price. Popular vehicles that are
low in supply may even fetch more than MSRP. To get a good idea what the market will
bear, try the “Live Quote” feature included in LeaseWizard® Software.
Residual Value
The residual value of a leased vehicle is the lessor's estimate of what the vehicle will
be worth at the end of your lease term. Sometimes referred to as the lease-end value, the
residual value is an important number to know for a couple of reasons. Your monthly lease
payment is based on the difference between the adjusted capitalized cost and the residual
value of the vehicle (we will discuss this fully in Chapter Three - Assembling the Pieces).
For that reason, knowing your residual value is essential in determining your repayment
liability. In addition, the residual value represents the minimum you should expect to pay if
you elect to exercise your purchase option at lease end (in a closed end lease). In an
open-end lease, the residual value takes on even greater importance.
Residual values are usually figured as a percentage of the vehicle’s MSRP. For
example, a $25,000 MSRP and a 50% residual factor will result in an estimated $12,500
residual value at lease end. You can get a pretty good idea of what the industry thinks the
residual value of your vehicle should be by consulting the industry-standard Automotive
Lease Guide.3 The ALG residual value on a vehicle represents what a reconditioned clean
vehicle should fetch at auction. That’s right, it’s wholesale, not retail. ALG values typically
represent the conservative end of the spectrum. At the other end of the residual rainbow
usually reside captive finance companies, which inflate projected residuals in order to
deliver lease incentives akin to rebates on vehicle purchases.
Residual values will vary depending upon the particular model you choose, the lessor (i.e. bank, captive finance company or independent leasing company), the amount of miles you anticipate driving, and particular promotions being offered on that model. In all cases, the lessor -- not the dealer -- sets the residual value (although some dealers have been known to shave the residual to earn more money on the deal). So, the best you can do is shop among different lessors for the most competitive number. You can expect variations among values offered by the captive finance companies, independent leasing companies, and banks. One way to shop residuals is to simply quiz the dealer’s finance manager to find out which lenders are offering aggressive residual values along with competitive rates. Before you get to the dealer, however, I recommend visiting LeaseWizard® Software for ALG and market residual values on virtually all makes and models sold in the United States. When shopping residuals, be sure to research similar type vehicles made by different manufacturers to take advantage of unusually high residual values being offered to aggressively promote certain models.
Those looking to enter into a closed end lease (most consumers), should shop for the highest residual value possible because the higher the residual value, the lower the monthly payment will be, all other things being equal. This occurs because the residual
value is subtracted from the adjusted cap cost to arrive at the amount you must repay over
the lease term.
Example 2.1
Low Residual: 18,000 - 9,000 = $9,000 (amount to repay)
Adj. Cap. Cost Residual
Higher Residual: 18,000 - 10,000 = $8,000 (amount to repay)
Adj. Cap. Cost Residual
Believe it or not, there are times when you might not wish to have a high residual value. If you are planning to enter into an open-end lease, for example, you will be safer with a less aggressive residual value. In an open-end lease, you are liable for the difference between the predicted residual value and the actual amount received by the lessor on the sale or auction of your vehicle at lease end. If the open-end residual value is artificially inflated to reduce the monthly payments, the shark will show up at lease end when the actual market value of the vehicle is lower and you owe the difference. If you are seriously considering a lease-end purchase, you may also be a candidate for a lower residual value because that is typically the amount you will be expected to pay for the vehicle. Of course, you must balance that possible saving against higher monthly payments.5 A low residual value also makes good sense if you are leasing a vehicle for business purposes and you have the opportunity to purchase it for personal use at lease end. Provided the vehicle is actually being used for business, the higher monthly payments may be deducted as a business expense during the course of the lease. Unless you fit into one of those categories, however, you will likely find yourself shopping for a high residual value in order to obtain the lowest monthly payment. Manufacturers are aware of this and often "push" the residual value in order to advertise and deliver lower monthly
payments. This usually operates to your benefit. TIP: High residual values offered by captive finance companies are often accompanied by low money factors. Shop, look and listen for this compelling combination!
Rent Charge
For reasons not apparent to most folks, the term "interest" or “APR” is absent from lease documents and, seemingly, from the vocabularies of most people in the vehicle leasing business as well. Instead, you will find terms such as rent charge, lease charge, lease factor or money factor. In their purest form, these charges all reflect the same thing - the cost of money! Why the fancy terms instead of interest which most everyone understands? There is actually a good reason for this. Technically and legally speaking, you are not borrowing money under a lease so “interest” is not really being charged. In fact, federal regulations will effectively prohibit the use of typical loan-interest terminology in leases. Behind the technical reason is a substantive disclosure issue. The reason a single rate cannot be applied to leases like an APR is used in loans stems from the inherent variability in leases from one consumer to the next. What does that mean? In plain terms, it means that certain items in a lease that affect the rate of return the lessor is receiving vary among individuals, and, therefore, cannot be uniformly applied to all leases. A lessee who returns his vehicle at lease end, for example, will generate one rate of return for the lessor while a different lessee of the exact same vehicle will generate another if he exercises the purchase option. In addition to problems in calculating a uniform rate, there are serious disclosure problems with a uniform lease rate.
One of the most interesting pitfalls is called “The Residual Loop”. A company named Bank Lease Consultants brought this phenomenon to the attention of the Federal Reserve Board during the formation of Regulation M in the late 1990’s. BLC showed that, if permitted, a lessor could confuse consumers by advertising a lower rate than his competitor and still charge exactly the same monthly payment on the same vehicle, simply by manipulating the residual value. Requiring a uniform rate disclosure would have allowed unscrupulous lessors to easily lure unwary consumers into more expensive leases by manipulating the residual value and then advertising extremely low “rates.” Suffice it to say that the absence of typical loan interest terms is not just a trick to make leasing more difficult for consumers - it’s a protection.
So how do we research and compare the cost of money under a lease? The most common way is through total or average monthly rent charges. The rent charge (commonly referred to as a lease charge) is comprised of a rate of
return on the lessor’s money as well as other costs of business such as gap insurance premiums, residual value guaranty insurance, vicarious liability insurance7, and fraud, skip and credit loss insurance. Federal law requires that the total rent charge be disclosed to consumers before they sign a qualifying lease. With the total rent charge, one can easily determine how much money they are paying each month for interest and the lessor's profit. Now, if you’ve had any experience with leasing, you are probably champing at the bit for me to explain where the money factor fits into the mix.
The Facts About Money Factors
Money factors are rate expressions used to calculate the average monthly rent charge. They typically appear as four or five digit figures preceded by a decimal point and look nothing like ordinary interest rates which are expressed in annual percentages (i.e. .0035 or .00312).8 If you are comfortable with numbers, try to obtain the money factor because it will be easier for you to run “what-if” scenarios and compare it to factors offered on other leases. Since the dealer or lessor can only give you a rent charge after calculating the entire lease (with residual, cap cost etc… already figured), you have much more flexibility with the money factor. With it, you can figure out the monthly rent charge and, with minimal manipulation, convert it into a number that approximates an annual money factor (i.e. .0000035 or 3.5 instead of .0035). If you see something like this, you can easily convert it by
moving the decimal point a few places. Some companies, like GMAC, Chrysler and Ford Motor Credit, either do
not use money factors or else have factors that do not even remotely look like those used by the majority of players in the industry.
Warning: Before attempting to convert your money factor into an approximate annual interest rate, be sure the number you have been given is actually a money factor and not an approximate annual percentage rate. For example, if you were told “two-nine” by the dealer you might not know whether the rate being charged was 2.9% or a .0029 money factor (which is approximately equal to 6.9%). The two are quite different. For this calculation, make sure you have a money factor! Sometimes referred to as a “lease factor” or “level yield factor,” the money factor is
simply a multiplier. It is not a rate! If you want to mess with the money factor, be sure you fully understand how the lessor uses it or you risk misunderstanding your deal. Money factors can vary from lessor to lessor. For example, one lessor may use a money factor of .0034 and calculate your average monthly interest multiplying that number by the sum of the adjusted cap cost and residual value. That would be typical (we will explore the math later). Consider, however, what would happen if the lessor’s formula took a conventional money factor, cut it in half (to .0017) and simply multiplied it by two before doing the other multiplication described above? That lessor could legitimately tell you he’s using a .0017 factor. But you would be comparing apples to oranges if you equated it with typical factors used by other lessors. Worse, your calculations would be off twofold if you did not know to multiply their factor by two before beginning your calculations.
If you are comfortable dealing with money factors, you should be able to get one from the dealer and crank through the numbers yourself. Assuming you get what you’re looking for, you should have no problem calculating average monthly rent charges or converting them into approximate annual rates for comparison purposes.
Unless you run a full-blown internal rate of return analysis, you’re unlikely to stumble upon the exact APR rate being charged under your lease. Fortunately, automobile leasing is not nuclear physics where infinitely precise numbers are always needed. For the vast majority of consumers, a close approximation will do fine for comparing deals.
Power Up Your Calculator!
Assuming the dealer gives you a conventional money factor of .0035 and you wish
to know the approximate annual rate, first multiply the money factor by 2400 as shown.
Example 2:2
.0035 x 2400 = 8.40% Approximate Annual Rate10
As a rule of thumb to enhance the accuracy of your calculation, you can add .07 (7 basis
points) to the result for every year the lease term is less than 36 months. In our example
above, the approximate annual rate on a 24-month lease would be:
Example 2:3
8.4% + .07% = 8.47% Approximate Annual Rate
Note: The approximate annual rate yielded by this calculation is essentially the lessor’s
rate of return. If there is an acquisition fee, the lessor’s rate of return will be higher.
If the dealer quotes you an annual rate (which he should not really do), but uses a
money factor in the calculations, you can cross-check the quoted rate by simply reversing
the equation and dividing the money factor by 2400 as shown.
Example 2:4
8.4% Annual Rate = .0035 Money Factor
Actually, multiplying by 24 will give you .084 the correct representation of 8.4%. Using 2400, however,
dispenses with the need to move any decimals - just add a “%” sign and you have it!
Monthly or Total Rent Charges
In your contract, the cost of money should be expressed as a total (and perhaps an average monthly) rent charge, rather than as an annual interest rate or money factor. For example, the dealer may disclose total rent charges of $5,000 on a 48-month lease. You can derive the money factor and a resulting approximation of the annual interest rate by performing the following calculations:
First, convert the total rent charge into an average monthly rent charge by dividing it by the term of the lease.
Example 2:5
$5,000 = $104.17 average monthly rent charge over 48 mos.
The resulting figure ($104.17 here) is the portion of your monthly payment, on average,
that represents the cost of money. Next, derive the money factor by dividing the $104.17
rent charge by the sum of the adjusted cap cost and the residual value. In our example, if
the adjusted cap cost is $18,000 and the residual value is $8,700, the money factor can be
calculated as follows:
Example 2:5
$104.17 (monthly charge) = .0039
$26,700 ($18,000 + $8,700)
Adj. Cap + Residual
If you want to know the approximate annual rate, simply multiply the money factor by 2400
as described in the previous section and you get:
Example 2:6
.0039 x 2400 = 9.36% Annual Rate
Did you notice how a mere difference of only .0004 from the .0035 money factor in Example 2:3, and the .0039 money factor from Example 2:5 resulted in nearly a full percentage point increase in the approximate annual rate of interest?!
Historically, dealers have referred to the rent charge as a “lease charge.” Although Regulation M encourages the
use of the term “rent charge,” you may hear the term “lease charge” until the industry catches up.
TIP: Keep in mind that the money factor or rent charge is only one measure of comparison among leases and you should not rely upon it exclusively when comparing two or more leases. Compare all aspects of your lease offers!
Lease Term
Although a longer lease term yields a lower monthly payment, generally be wary of lengthy leases. As with a loan, the longer the lease term, the more you will pay in interest charges. In addition, the longer the term, the more likely it is you will have to make major repairs to a vehicle you do not own. For that reason, I recommend that the term of your lease not exceed the life of the warranties covering your vehicle. If your budget forces you to consider only leases with terms exceeding the vehicle warranty, you are usually better off looking at a less expensive vehicle. Another view on this issue held by at least one esteemed leasing expert is that the cost of repairs should be considered separately from the issue of how you intend to finance the vehicle (i.e. lease or buy). According to that
view, you risk paying for repairs regardless of whether you lease or buy because you are obligated to return the leased vehicle in good working condition and with only ordinary wear and tear -- presumably the same way you would treat the vehicle had you bought it. In my view, one of the primary benefits of leasing is the ability to push the risk of repair over to the lessor by leasing for a term that is less than the length of the warranty. If, on the other
hand, you lease with the intention of exercising the purchase option, you probably do not need to treat the repair issue any differently than you would in a purchase situation. Another factor you should consider is that statistically, most people do not stay in their 48-60 month leases for the full term. That means they are terminating their leases
early and usually paying a premium to do so. To add insult to injury, the rates offered on longer term leases are typically not as aggressive as those accompanying 24-42 month leases. Unless you know you will exercise your purchase option, choose a shorter lease.
If you insist on entering a longer-term lease to obtain the lower monthly payments, at least look for a vehicle that ranks high in its ability retain value. Better cars will fare better on early termination where you receive credit for the actual or estimated wholesale auction price of your vehicle. Keep in mind, however, that leases are designed to permit you to pay in as little as possible in order to get you to zero equity by the time your lease expires. Generally, you can expect to be "upside down" (in other words, you will owe more than the car is worth) on your lease until you have reached the end of your term. If you terminate early and “roll into a new lease,” prepare to have the negative equity rolled into your new lease, making the payments higher than they should be for the new vehicle.
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