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Fundamentals of Lease Payments

When it comes to the topic of leasing a vehicle, it’s not uncommon to hear people say that they don’t know much, or anything at all, about how leasing really works. Specifically, the topic of how lease payments are calculated seems to be one of the most popular questions about leasing.

Let’s take a closer look and shed some light on how lease payments are figured. First, let’s look at the basics - the five figures you’ll need in order to calculate a monthly lease payment:

Residual Value = (MSRP) x (Residual Percentage)

Monthly Depreciation = (Adjusted Capitalized Cost - Residual Value) / Term

Monthly Rent Charge = (Adjusted Capitalized Cost + Residual Value) x (Money Factor)

Monthly Tax = (Monthly Depreciation + Monthly Rent Charge) x (Tax Rate)

Total Monthly Lease Payment = Monthly Depreciation + Finance Charge + Tax


Now, let’s translate what each of these items refers to:

Residual Value

This is our estimate of what the vehicle will be worth at the end of the lease, and it’s used to determine the monthly lease payment. The higher the residual value, the lower the monthly payment will be. The residual value is expressed as a percentage of the MSRP.

MSRP

The Manufacturer’s Suggested Retail Price: sometimes referred to as the ‘sticker price’ because that’s where you find it - on the vehicle’s window sticker; you can also find it on the dealership’s website.

Depreciation

In general, depreciation is the rate at which a vehicle’s value declines over time. When it comes to leasing a vehicle, you’re paying for the depreciation that occurs from your use during the length of your lease, plus the interest and fees (like those of the title and registration).

Adjusted Capitalized Cost

Refers to the amount financed, which is the total amount calculated to include the negotiated selling price of the vehicle, plus things like title and registration fees as we mentioned above, and minus things like any possible rebates or a down payment.

Term

Another name for the length of the lease. Most leases are 36 months, but other terms may be available. 

Money Factor

Similar to an interest rate on a financed vehicle; the money factor is always expressed as a very small number, such as 0.00125.

Tax Rate

It’s important to understand your state’s tax treatment of leased vehicles, but generally you only pay tax on the leased portion of the vehicle - although, some states do require tax on the selling price of the vehicle. Consider both the state tax rate, and also whether you have any local or county taxes.


Lease Calculation Example

Let’s take a look at a sample lease payment calculation:

In this example, we’re going to lease a car with an MSRP of $25,000, a residual value of 58% and a money factor of 0.00125. We have a $1,500 down payment plus a $500 Military Rebate, but no trade in. If we negotiate a sales price of $23,500 and have $1,000 in fees, for a term of 36 months, here’s what our monthly lease payment calculation would look like:


1. Determine the Residual Value

Residual
            Value (MSRP) x (Residual Percentage)
$25,000 x 0.58 = $14,500
Residual Value
= $14,500

2. Calculate the vehicle's Monthly Depreciation

Depreciation (Adjusted Capitalized Cost - Residual Value) / Term

To calculate the adjusted capitalized cost, you’ll take your negotiated sales price of $23,500 and add your $1,000 in fees, and the resulting number is your gross capitalized cost. Separately, you’ll need to add together your down payment of $1,500, trade-in equity (in this example we have no trade), and any rebates, in our case the $500 Military Rebate, to determine what’s known as your capitalized cost reduction.

$23,500 + $1,000 = $24,500 gross capitalized cost
$1,500 + $500 = $2,000 capitalized cost reduction
Then we subtract the capitalized cost reduction from the gross capitalized cost, for a total that is known as the adjusted capitalized cost.

$24,500 - $2,000 = $22,500 adjusted capitalized cost
Now, we can use our formula for monthly depreciation:
(Adjusted Capitalized Cost - Residual Value) / Term
($22,500 - $14,500) / 36 → $8,000 / 36 = $222.22
Monthly Depreciation
= $222.22

(this total is sometimes also know as the base payment)


3. Calculate the Monthly Rent Charge

Finance Charge (Adjusted Capitalized Cost + Residual Value) x (Money Factor)
$22,500 + $14,500 x 0.00125 = $46.25
Monthly Rent Charge
= $46.25



4. Determine your Monthly Tax

Sales tax (Monthly Depreciation + Monthly Rent Charge) x (Tax Rate)
For this example, we’ll calculate based on a 6% tax rate.
$222.22 + $46.25 x 0.06 = $16.11
Monthly Tax
= $16.11


5. Calculate your Monthly Lease Payment

Payment Monthly Depreciation + Rent Charge + Tax
$222.22 + $46.25 + $16.11 = $284.58
Total Monthly Lease Payment
= $284.58