Leasing is like renting a car for an extended period. Instead of paying the full purchase price, like you would if you were buying the vehicle, you just pay for the amount of depreciation that is expected to occur during the term of the lease, plus interest and fees. Most auto leases are closed-end leases, with the residual value at the end of the lease locked in before you even drive off the lot.
You usually, but not always, have to make a down payment on a leased car. The remainder of the lease cost is split into a series of equal monthly payments that include interest. Typical lease terms are for two or three years, though a lease agreement can be written for almost any length.
While leasing sounds simple in concept, getting a lease is a complex financial transaction that even comes with a vocabulary that’s different than car buying. Here are a few terms you’ll want to know if you’re considering a car lease:
Capitalized Cost: A vehicle’s capitalized cost (also known as cap cost) is the price of the car. Like with a car purchase, you should negotiate to get this price as low as possible. With most automotive-sponsored lease deals, this price is fixed. With most other leases, it’s important to haggle to get this price as low as possible.
Any discounts off the capitalized cost, such as special lease deals from automakers, are called cap cost reductions.
Residual Value: The residual value of a leased car is an expert’s opinion about its expected value at the end of the lease term. A residual that is a higher percentage of a vehicle’s cap cost is good, while a low residual force you to pay a higher portion of a car’s capitalized cost.
Different cars depreciate at different rates than others. Your best lease deals can be found on cars that depreciate the least, and have higher residual values.
Money Factor: It would be way too easy for leasing companies to use an interest rate when discussing lease contracts. Instead, they use a number called the money factor to represent the amount of interest that’s included in each monthly payment.
To convert the money factor to a more familiar interest rate, you multiply it by 2,400. You can either do the math yourself or use an online money factor calculator to perform the conversion for you.
What Do You Pay for With a Car Lease?
The cost of the lease is the capitalized cost minus the residual value, plus interest (the money factor) and several fees. In addition to lease origination costs, you’ll also have to pay registration fees, just as you would with a car purchase.
For example, let’s say you’ve found the perfect Mercedes-Benz SUV. It has a capitalized cost of $50,000 and a residual value after three years of $30,000. To lease the luxury SUV, you’ll have to pay the difference between the two numbers ($20,000) plus interest and fees. If they ask for $3,000 plus fees upfront, the remaining $17,000, plus interest, is split into a series of equal monthly payments. Payments will last until the final lease month. Then you have to return the vehicle to the dealership.
Dealerships will usually refer to the down payment, any lease fees, security deposits, and the price of registration as drive-off costs.