Leasing a vehicle is based entirely on the idea that you only pay for what you use. Most modern leases will guarantee the value at the end of the lease term. The purpose of this article is to familiarize you with the terms you will see and hear when you visit the dealership.
Manufacturer's Suggested Retail Price = MSRP
MSRP is the full price for a vehicle as displayed on its window sticker, including optional packages and destination charges. Dealer documentation fees, registrations and taxes are not considered part of MSRP, although these charges are part of your total cost.
When you and your dealer sit down and agree on a price for a leased car, this becomes the capitalized cost, or "cap cost." Think of it as the "actual" selling price you both settle on. Cap cost is sometimes called lease price. Capitalized Cost may also include certain fees, such as an acquisition fee (similar to mortgage "points" , or loan origination fee). If you haven't fully paid off the vehicle you're trading, cap cost would also include any remaining loan balance ("negative equity") after trade-in credit is applied (this is not a good practice if you can avoid it).
Capitalized Cost Reduction
Capitalized Cost, (lease price), can be greatly reduced by rebates, factory-to-dealer incentives, your trade-in, or just a cash down payment. These are known as cap cost reductions.
Even modest cap cost reductions, such as a down payment, will give you smaller monthly lease payments, especially in shorter leases. When you subtract cap cost reductions from cap cost, you get net capitalized cost, sometimes called adjusted cap cost.
Depreciation is the difference between a vehicle's selling price and its value at lease-end (residual value), and is the main factor in determining your payments.
If you consider two vehicles, both selling for $30,000 when new, where one is worth $21,000 after three years and the other worth only $16,000, the first car will have a lower monthly payments because of its higher retained value.
This is why reliable, well built cars with traditionally high resale values are always a better lease option. Normally Japanese makes have a higher resale value than American brands. Toyota and Honda have consistently held low depreciation ratings, as has Lexus, BMW and other luxury brands.
The wholesale worth of a car at the end of its lease term, after it has depreciated, is called its residual value. As mentioned before, the higher the residual value, the more the car is worth at lease end...and the lower your monthly payments. Since nobody can truly predict the future, residuals are only educated guesses based on historical resale-value data for specific automobile makes and models.
Car manufacturers' leasing companies often temporarily boost residuals on slow selling vehicles so that they can offer better lease deals. These are called subvented deals.
Residuals are usually stated as a percentage of MSRP. A 36-month, 50% residual on a new $30,000 car means that its estimated depreciated value at the end of a 3 year lease will be $15,000. The actual value at the end of 36 months might be higher or lower.
Residuals decrease as the length of a lease, (the term), increases. This is obviously because the older a vehicle gets, and the more you use it, the less it's worth at the end.
Residuals generally decrease quickly in the first two years, then more slowly in later months. This is why shorter term leases are more expensive than longer leases.
A good rule of thumb is to lease vehicles whose 24-month residuals are at least 50% of their original MSRP value.
Remember, the higher the residual, the lower the lease payments.
When you lease, you're tying up the leasing company's money while you're driving their car. Exactly the same as the mortgage on your home. Remember, they spent their money to buy your car from the dealer so that they could lease it to you. They rightfully expect you to pay interest on that money, the same as with that mortgage.
This interest is expressed as a money factor, sometimes called lease factor, or simply "the factor", and is specified as a small decimal number such as .00057.
Money factors can be converted to annual interest rate (APR) by multiplying by 2400.
For example, Toyota has a current money factor on the Camry of 0.00057, multiply that by 2400 and you come up with an equivalent interest rate of 1.368.
Another good rule of thumb: Lease money factors, converted to APR, should be comparable to, if not lower than local new-car loan interest rates. Like interest on a loan, the lower the money factor, the lower your monthly lease payments.
Lease term is the length of time a car is leased, usually expressed in months. Typical leases are 24, 36, or 48 months.
Try to choose a lease term that's no longer than the general coverage warranty that comes with your vehicle. That way, you're covered for the entire duration of the lease if something breaks. For example, if a vehicle's "bumper-to-bumper" warranty is 36 months, don't lease it for longer than 36 months as many major vehicle problems start in the fourth or fifth year as wear and tear begin to show.