How Car Lease Payments Work
Just as with any vehicle, your leased car depreciates in value as you accumulate more miles and the vehicle experiences normal wear and tear. To account for the loss in value, your leasing company requires a portion of your monthly payment to be directed towards depreciation.
Ultimately, your monthly payment will be largely based on:
- The capitalization cost
- The residual value
- A money factor in place of an interest rate
The Capitalization Cost
When you purchase a vehicle, you will pay the sticker price or purchase price of the vehicle over a set number of years. However, leases have a capitalization cost representing the value of the vehicle at the beginning of the lease in addition to any extra fees, taxes, etc.
Similar to the sticker price or purchase price of a financed vehicle, the capitalization cost is the amount you’ll pay for the use of the leased vehicle. Generally, the lower the capitalization cost of your lease vehicle, the lower your monthly payments.
The Residual Value
The residual value of your lease is a fancy way of explaining how much the leasing company expects the vehicle to be worth at the end of the lease. Your residual value is based on the number of miles you agree to drive each year — such as 10,000, 12,000, or 15,000 — and the term of the lease.
At the end of your lease, you’ll have the option to buy the vehicle at the residual value — regardless of what the vehicle is valued on the open market at the time. This simple lease-to-buy option means you’ll know the resale value of your vehicle from the beginning and can potentially purchase a vehicle below market value or simply walk away.
It’s important to understand the higher your residual value, the lower your monthly payments. For this very reason, a growing number of people are choosing to lease a car — instead of purchasing the same vehicle and paying much more.
The Money Factor
The other component determining your lease payment is the money factor. While traditional vehicle financing includes an interest rate representing the risk the lender takes for loaning you money to purchase the vehicle; leases include a money factor, which is not the same as an interest rate.
The lease money factor represents the compensation you pay to the leasing company for the risk they take by trusting you’ll make all lease payments on time. Money factors are not expressed in annual percentage rates (APR). In contrast, money factors are written as long decimals. Although it may seem confusing, converting your money factor into APR is simple — just multiply the money factor by 2,400.