Car Leasing Terms Explained in Plain EnglishCar leasing is very similar to renting. It makes "owning" a new car more affordable (at least in the short-term).
Contrary to what most people think, car dealers are not the ones who offer leases. Leases are actually done through leasing companies, banks, or the finance division of a car manufacturer (such as GM Financial or Ford Motor Credit).
When you lease a car, the dealer sells the vehicle to the leasing company at the price you negotiate (read our negotiating guide). The leasing company then turns around and leases the car to you based on that purchase price.
This is why it's so important to negotiate the selling price of the car first before leasing. Car dealers love the confusing nature of a lease because it's easy for them to pad on extra profits without you ever realizing it.
Leasing Terms Explained in Plain English
In order to understand leasing, you need to understand the following terms used to calculate your monthly payments. (don't worry, it's simple once you understand).
This is the most important part of a lease, sometimes referred to as "cap cost". It's the negotiated selling price of the car plus any additional fees you might want to include in the monthly lease payment (such as acquisition fee). The lower you negotiate the purchase price of the car, the lower your monthly payment will be.
Most dealers will try to charge MSRP (Manufacturer's Suggested Retail Price). Don't fall for that - negotiate just like you would if you were buying the car outright.
Capitalized Cost Reduction
"cap reduction", this is basically anything that lowers the cap cost - such as a down payment, trade-in allowance, or rebates. Assuming you negotiated the purchase price at $25,000 and you put $3,000 as a down payment, your capitalized cost is now $22,000 and your capitalized cost reduction is $3,000.Adjusted Capitalized Cost
Sometimes referred to as "net capitalized cost", it's the cap cost minus the cap reduction. This is the figure the leasing company will use to determine your monthly payments.Acquisition Fee
This is the fee leasing companies charge to arrange the lease and is usually just a straight profit for them. Not all leasing companies charge this fee, but when they do, it's usually between $400 and $750 - and it's not negotiable. The acquisition fee can be bundled into the monthly lease payment by adding it to the Capitalized Cost.Depreciation
You've probably heard the saying that the value of a new car drops 15% as soon as you drive it off the lot. This statement refers to depreciation.
Typically, the price of a new car drops 50% after 3 years. Remember that the leasing company actually owns the car and is "renting" it out to you.
The problem is, when you return the car, it's going to be worth a whole lot less than when you first started leasing it and you're going to have to pay for this loss in value.
Therefore, depreciation makes up the largest part of your lease payment so you need to pay close attention to this. Some cars depreciate more than others. Cars like BMW and Mercedes retain their value well, which explains why many of their sales go to leasing. (See: Best Cars to Lease if You Want a Great Deal)
This is the amount your car is worth at the end of the lease. Depreciation and Residual go hand in hand - if you know one, you can calculate the other.
Let's say you purchased a car for $30,000. After 4 years, the depreciation on the car is $20,000 - therefore, the residual is $10,000.
The residual value is calculated before you sign the lease. Most leasing companies use the Automotive Leasing Guide (ALG), an industry guidebook that calculates the predicted values of new cars after they come off lease.
This is what confuses most people when it comes to leases. Money factor is actually pretty simple, it just refers to the interest rate but is calculated differently. (Again, car dealers love the confusion since it allows them to add in hidden profits)
The money factor is represented as a number such as ".0029". To convert this to a more familiar interest rate, you simply multiply by 2,400. A money factor of .0029 equals roughly 7% interest.
Here's a table showing you what each money factor converts to:
Interest Rate Money
Interest Rate Money
Interest Rate 0.0005 1.20% 0.0037 8.88% 0.0069 16.56% 0.0006 1.44% 0.0038 9.12% 0.0070 16.80% 0.0007 1.68% 0.0039 9.36% 0.0071 17.04% 0.0008 1.92% 0.0040 9.60% 0.0072 17.28% 0.0009 2.16% 0.0041 9.84% 0.0073 17.52% 0.0010 2.40% 0.0042 10.08% 0.0074 17.76% 0.0011 2.64% 0.0043 10.32% 0.0075 18.00% 0.0012 2.88% 0.0044 10.56% 0.0076 18.24% 0.0013 3.12% 0.0045 10.80% 0.0077 18.48% 0.0014 3.36% 0.0046 11.04% 0.0078 18.72% 0.0015 3.60% 0.0047 11.28% 0.0079 18.96% 0.0016 3.84% 0.0048 11.52% 0.0080 19.20% 0.0017 4.08% 0.0049 11.76% 0.0081 19.44% 0.0018 4.32% 0.0050 12.00% 0.0082 19.68% 0.0019 4.56% 0.0051 12.24% 0.0083 19.92% 0.0020 4.80% 0.0052 12.48% 0.0084 20.16% 0.0021 5.04% 0.0053 12.72% 0.0085 20.40% 0.0022 5.28% 0.0054 12.96% 0.0086 20.64% 0.0023 5.52% 0.0055 13.20% 0.0087 20.88% 0.0024 5.76% 0.0056 13.44% 0.0088 21.12% 0.0025 6.00% 0.0057 13.68% 0.0089 21.36% 0.0026 6.24% 0.0058 13.92% 0.0090 21.60% 0.0027 6.48% 0.0059 14.16% 0.0091 21.84% 0.0028 6.72% 0.0060 14.40% 0.0092 22.08% 0.0029 6.96% 0.0061 14.64% 0.0093 22.32% 0.0030 7.20% 0.0062 14.88% 0.0094 22.56% 0.0031 7.44% 0.0063 15.12% 0.0095 22.80% 0.0032 7.68% 0.0064 15.36% 0.0096 23.04% 0.0033 7.92% 0.0065 15.60% 0.0097 23.28% 0.0034 8.16% 0.0066 15.84% 0.0098 23.52% 0.0035 8.40% 0.0067 16.08% 0.0099 23.76% 0.0036 8.64% 0.0068 16.32% 0.0100 24.00%
The term of the lease is how long you will be leasing the car for. Most leases have 24, 36, 48 and 60 month terms. the longer your term, the lower your monthly payments, however, you'll end up paying more in interest.
This is the person who will be leasing the car - you!
This is the leasing company. They are the ones who legally own the vehicle. This can be a bank, an independent leasing company, or the finance division of a car manufacturer.
Gap insurance protects you in case the car is stolen or totaled. Most leases come with gap insurance for no additional charge, but if it doesn't, make sure to get it. (See: Why You Need to Have GAP Insurance When Leasing a Car)
Not all leases require a security deposit. This is very similar to when you rent a house and the landlord requires a security deposit in case you damage the residence. A security deposit with a lease ensures that you will pay any damages you cause to the vehicle when you turn it in.
Leasing companies claim this charge is to cover their expenses when it comes to cleaning and selling the car after you turn it in at lease-end, but it's usually another profit center for them. Most charge around $250.
Each week, I'll keep you up-to-date on the latest car deals and news that might affect your purchase. This includes...
- Best Rebates, Incentives, and Lease Deals
- Latest Car Buying Scams and Tricks
- The Best & Worst Time to Buy a Car
- Which Cars You Should Avoid