How Do Car Leases Work? A Guide To Understanding Car Leases And Terminology

Understanding Car Leases and Terminology

So, you're thinking, this time around maybe I'll lease instead of buying. I don't drive that many miles to work, it would be nice to get a new car for less than buying and keeping it in warranty! It sure is difficult to get good info especially looking at the ads in the auto section of the newspaper. And dare you ask the salesman and let him steer you?

So here we go:

Firstly, Leasing is not renting. When you buy a new car on the dealer showroom floor either you (or your financial company) owns it. When you lease a car from a major manufacturer, you aren't leasing from the dealer. You are leasing from a lease company affiliated with the dealership (usually a parent financial company connected to the manufacturer). The leasing company buys the car from the dealer and agrees to let you drive it for a specified time with a maximum number of miles ie: 36 months, 12,000/year max. This is called the term and is set by the leasing company up front (sometimes the miles are more/less-10,000 or 15,000 and the month amount could be more or less 24, 48).


What you pay for in a lease is the depreciation over the time you have possession of the automobile. Also there is an interest rate called the money factor. When the leasing company purchases the car up front, you are tying up their money for the whole car while you drive it paying them a little per month. The money factor is a number after a decimal point... Something like.00325 and can be converted to an APR by always multiplying this rate by 2400. (.00325 X 2400 = 7.8%APR)

Also, set by the leasing agent is the depreciation rate. The residual is the estimate by the leasing company what the car would be worth after the lease is completed. It's often measured in percentage. Anything over 50% is considered excellent. The higher the residual--the better for you (the more the car is worth after the lease, the less it depreciates, and the less you'll pay).

Since so far it seems like the leasing company is calling all the shots, how do you get a good deal? Many people don't realize that you negotiate the MSRP (the sticker price) just like you do if you are buying a car. In leasing this is called the Capital (Cap) Cost. Of course, the salesman probably won't volunteer this information to you. Negotiate as you would a purchase by starting with the invoice price and going up from there. Then you can consider your trade in. After you've adjusted the Cap Cost, it becomes the Adjusted Cap Cost. The Adjusted Cap Cost divided by the term will be the significant portion of the monthly rate you pay.

The other portion of that payment will be the finance fee, which is the money factor multiplied by the (adjusted cap cost + residual). There are some excellent lease calculators online to help with this.

The remaining portion will be, of course, the sales tax which differs by state as to which amount of the car's value you are taxed on (commonly just the depreciated value).

Of course there are a few other fees, acquisition fees, doc/title fees that sometimes get wrapped into the payment but other times get paid up front.

How do car leases work? I hope you are starting to understand the process!

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