What is Leasing?

Updated: Sep 30, 2020

I must admit, most folks will think that there is a lot that goes into calculating your monthly lease payment! Let me fill you on a little secret...there isnt. By the end of this post, you will know how to calculate your monthly lease payment by hand! YES WE CAN!

What you’re paying for

Despite leasing’s bizarre vocabulary, the concept is simple and relatively easy to understand. When you lease, you’re paying for these three main elements:


(1) The principal and the interest on the depreciation — which is the difference between the price you negotiate (which the leasing company pays to the dealer) and the residual value (what the car will be worth when the lease ends).

 (2) The interest on the residual value — which you’re borrowing and driving around for the lease term.

 (3) The sales tax — which is typically your local retail sales tax rate times the sum of the monthly payments for those first two items.

There are some additional costs too…

You’ll pay a lease “acquisition fee” (sometimes called a “bank fee” or “initiation fee”). This is usually in the range of $600 to $1,000. (It’s highest on luxury cars.) This money goes to the leasing company, not the dealer. It is non-negotiable.

There will also be a “disposition fee” — usually a few hundred dollars — if you don’t buy the vehicle at lease-end. This amount will be listed in your lease agreement. It also goes to the leasing company and is non-negotiable.

These fees are important revenue sources for the automakers’ captive finance companies, which write the lion’s share of retail leases. They have more expenses on leases than on purchases. If you don’t buy the car at lease-end, they must inspect it, fix whatever needs fixing, then send it to an auction to sell it to their dealers. Most off-lease cars end up as “factory-certified” used vehicles, an important revenue source for car stores. (They make a higher gross profit margin on used cars than on new ones.)

What you can and can’t negotiate

The only element you can negotiate is the price at which the dealer sells the car to the leasing company.

The leasing company sets the residual value (its worth at lease-end usually in the form of a percentage). They base this on the Automotive Lease Guide’s residual percentage tables, which, depending on the miles driven per year, list projected wholesale values of vehicles after two, three, four, five and six years. Those are realistic estimates of the prices they’ll get at auction from the brand’s dealers. Residuals are always stated as a percentage of a vehicle’s total sticker price (MSRP).

The leasing company also determines the interest rate, or “money factor.” Lessees with the highest credit scores typically get the best rates, just as they do if they’re buying. Lower credit rating, means higher money factor.

All dealers quoting on leases from an automaker’s captive finance company (i.e: Audi Financial Services) should be singing the same song on both the residual value and the money factor (assuming you have no credit glitches).

How to calculate your monthly payment by hand

It’s 5th grade arithmetic. You don’t need leasing software. Any basic calculator will suffice.

Let’s assume you want a 3 year lease, 15,000 miles a year.

To calculate the lease payment, you need the following information, most of which you should be able to get from the dealer:

• The full retail/sticker price (MSRP) of the car.

• The “agreed-upon price” you’ve negotiated.

• The amount of the drive-off check, with each element detailed.

• The “final,” or “net,” or “adjusted” capitalized cost, with details of anything that’s been added to or subtracted from the agreed-upon price of the car to get to the total.

• The residual value, which is always a percentage of the full retail/sticker price (MSRP). (Dealers will quote this as either a percentage or a dollar figure.) It will be the “buy-out price” in your lease document.

• The “money factor” or interest rate the leasing company is using.

Let’s use these assumptions to illustrate how they calculate the monthly payment:

• A 36-month lease. 12,000 miles per year.

• A retail/sticker price of $24,000.

• An “agreed-upon”/negotiated price of $22,000.

• A residual value of $12,000, 50% of the MSRP.

• A money factor of .00125. (Multiply this by 24 to reveal the interest rate. This one is 3.0%.)

• A local sales tax rate of 6.5%.

Assume that our “drive-off” check will cover the first month’s payment, a $400 vehicle registration fee and a $600 lease acquisition fee.

That leaves the $22,000 negotiated price as the “final/net/adjusted” capitalized cost.

So our monthly payment calculation goes like this:

1. The monthly depreciation charge

$22,000 (the final/net/adjusted capitalized cost) minus $12,000 (the residual value) leaves $10,000 in depreciation. Divided by 36 months, that’s $277.78 per month.

2. The monthly interest charge

To get this number we add the capitalized cost ($22,000) to the residual value ($12,000) and multiply the $34,000 total by .00125 (the money factor), making the monthly interest charge $42.50.

3. So the pre-tax monthly payment is $277.78 + $42.50, a total of $320.28.

4. Adding the 6.5% sales tax of $20.82 makes our total monthly lease payment $341.10.

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