Learn the Language
Lease deals use some specific vocabulary that’s important to understand. MSRP, or Manufacturer Suggested Retail Price, is the automaker’s recommended price for a car. Between you and me, however, just because the manufacturer suggests that price doesn’t mean you’ll need to pay it—even in today’s car market, negotiation is still a part of most deals.
And that is where net capitalized cost, or net cap cost comes into play. This is the price of the car after you’ve negotiated down from the MSRP using manufacturer rebates and discounts, your down payment, and the value of your trade-in (if you have one), but also after the dealership has tacked on its necessary fees. These fees are not usually a tactic to eke out more money from a customer, but simply costs associated with running the business. They’re usually referred to as title and registration (collected for the state), document (the cost of handling paperwork), and occasionally acquisition fees (what a leasing company will charge a dealership to provide the leased car).
Generally speaking, the cost of a lease to a shopper is based on three items. First, there are unavoidable taxes and fees. Simply put, if you buy or lease a car, regardless of where you live, you’ll need to register it—and far be it from your state government to offer registration for free. Regarding taxes, leases offer a major benefit over buying a car in that the shopper is required to pay taxes on only the lease payments, not on the total cost of the vehicle.
Next up is depreciation. As we discussed in 10 Good Reasons to Buy a Used Car, as soon as a vehicle leaves a dealership lot and starts adding miles to the odometer, its value begins dropping. When structuring lease deals, the majority of the shopper’s payment is directed toward covering this cost of depreciation. Residual value is the amount the automaker estimates the vehicle will be worth at the end of the lease term. Essentially, the lower the percentage of the vehicle’s original MSRP the residual value is, the more expensive your lease payments will be.
Finally, while many shoppers look at leases as long-term rentals, where you’re paying for only the cost of the car’s depreciation over the loan term, there’s actually one other critical element in the dealership’s monthly payment formula: the money factor.
The money factor is set by the manufacturer, rather than the dealership, and each one is specific to a make and model. Higher volume cars like a Honda Civic will typically have very low money factors, whereas a Honda Pilot would usually have a higher one. When a carmaker needs to boost sales of a particular model, it will usually lower that model’s money factor. However, this isn’t a figure you can negotiate with the dealership.
When a dealership leases you a car, it adds the cost of interest by multiplying the money factor by the car’s net capital cost plus the residual value—yes, that’s correct: your lease deal’s interest is based on the negotiated price of the car plus the car’s expected residual value. The money factor is displayed as a very small number—sometimes as low as .001. If you want to determine what the equivalent annual percentage rate (APR) of your money factor would be, just multiply it by 2400.
Do the Math
Let’s say you’re in the market for a new Subaru Impreza. The dealer has a great-looking example on the lot, priced at $26,500. You don’t have a trade-in, and you’re not interested in making a down payment. After a bit of negotiation, you’re able to work the dealership down to an even $25,000. The anticipated residual value of the Impreza after 3 years is $16,000, and the dealer is offering to lease it for 36 months with a money factor of .0023.
Based on the net cap cost minus the residual value, you’ll be responsible for covering $9,000 over 36 months, or $250 per month. The dealer will then calculate the finance fee of the lease by multiplying the money factor (.0023) by the net cap cost ($25,000) plus the residual value ($15,000), which comes out to $92 per month. Written as an equation, it would look like this:
($25,000 + $15,000) x .0023 = $92.00
That $92.00 is tacked onto each month’s $250 lease payment for a total of $342.00. If your state’s tax rate is 6.5%, you’d pay that tax on each lease payment, driving the monthly cost up to $364.23
That seems like a lot of money, especially if the dealer lured you in with a promise of a $250-per-month lease. When you purchase, rather than lease, you pay tax on the cost of the entire car. So, if you choose to buy the car outright via 36 monthly payments, and you’re looking at a monthly payment of $739.58:
($25,000 x 1.065) ÷ 36 = $739.58
Decide Which Is Best for You
The opportunity to cut nearly 300 dollars from a monthly payment is an attractive one, and more and more shoppers are opting to lease cars rather than buying them. The obvious caveat, however, is that when you lease a car, there’s an expiration date – at the end of the lease term, you have to either give the car back to the dealership or spend even more money to buy it. And if you’ve gone over your allocated mileage or if the car has sustained any damage beyond normal wear and tear, you’ll pay extra for that, too. If you choose to buy from the beginning, you’ll pay more, but you’ll get to take home both the car and its equity.
If you’re the type of person who likes to drive newer cars and you don’t care about owning your vehicle, a lease can be a smart choice. With maintenance plans often included and terms that almost never exceed the vehicle’s warranty, leases are a great way to build car ownership into your personal budget.
If you’re the type who’d rather drive a car into the ground, buying is the clear answer. Your monthly payments will likely be higher and paying for the car will take longer, but once it’s paid off, you’ll actually own the car in your driveway, and your leasing neighbors won’t.