No bones about it: Leases are confusing. There’s all kinds of figures and fees. The numbers from one dealer can be expressed in a different form factor at another. Sometimes it feels like comparing apples to oranges. We here at Instamotor want to take the mystery out of leasing a car (and make sure you are getting the best deal) so we put together a primer on how to evaluate a lease.
What Is Residual Value?
First, examine the residual value. Not sure what “residual value” means? We’re here to help. Not too long ago we put together a glossary of car-buying terms to help you get a handle on all those wonky financial terms. Check it out here. We suggest scanning the other terms while you're there. It will be really helpful to have your head around many of them when you sit down to negotiate.
At its core, residual value is the estimated value of the car at the end of the lease. The residual values are determined by a company called ALG or by the bank that holds the lease, and is based on a number of factors including the brand of car being leased, how many miles were put on it, and the wear and tear on the vehicle. ALG releases annual “Residual Awards” for vehicles and brands that hold the most value. You can check out the most recent list, here.
Breaking It Down
Why does residual value matter? Well, the higher the value at the end of the lease, the less of a payment you are going to have to carry. When you lease a car you are basically responsible for three main parts of the financing, according to Clark Howard.
- Principal and the interest on depreciation: When you lease you are taking out a loan. The cost of that loan becomes a large part of your monthly payment. You are essentially paying the interest and the depreciation on the car you are leasing.
- Interest on the residual value
- Sales tax
Say for example that a car you are looking at leasing costs $30,000. At the end of your three year lease, the car is going to have a residual value of $15,000. That means that your $30,000 will cost you $15,000 plus interest over three years. A simple way to estimate the cost would be to divide that $15,000 by 36 months to figure out what the base cost of the lease will be each month. Your base payment without interest, taxes, or other fees, will be $416 a month. If you choose a car with a higher residual value--say it retains 65% of its value at the end of the 3-year lease, your base payment will be lower. Think of it this way:
65% of $30,000= $19,500 Which is the residual value or what your car will be worth when it comes off of lease.
$30,000-19,500= $10,500 That is the principal that you will be paying over the life of the lease.
$10,500 / 36 months= $291.67 per month in principal payments
All that math shows you is that it makes more sense to lease a car that has a higher residual value.
Understanding The "Money Factor"
In addition to the residual value, you need to consider what most dealers will call the money factor or a lease factor. This is usually expressed as some weird decimal that, in the larger context, outside of car buying, almost never makes sense. Let us break it down for you.
The money factor or lease factor is the way that dealers express the interest rate they’re offering. With a little math you can figure out what the APR is if a dealer gives you the money factor. So, for example, if a dealer is offering a 0.002 money factor or lease factor, multiply that number by 2,400 to get the actual APR. Using our example a 0.002 money factor would mean that the APR would be 4.8%. In some cases the money factor or lease factor may be presented as a whole number like 2.0. You can still do the math and figure out what the real APR is by multiplying by 2.4. While you can’t necessarily negotiate a money factor with a dealer (they don’t set them, their financing arms do), you can take that knowledge to an outside bank to see if you can find a better deal.
It is possible to finance a lease outside of the dealership. Visit various banks to get their lease rates and then return to the dealer with those rates. See if they can do anything to meet the deal by, say, lowering the agreed upon price of the car. You’ll end up saving even more money. We’ll do a deep dive on how to get a lease deal from an outside bank in an upcoming post, so stay tuned.
Read the Fine Print Before Signing On The Dotted Line
The other things to consider when assessing a lease deal is to take a look at the fees and taxes. If you look at the fine print on your lease deal you’ll notice things like security deposit, disposition fees and acquisition fees. Despite appearances, these fees are not the same from manufacturer-to-manufacturer and company-to-company. It’s worth doing your homework and shopping around--even from one dealer to another within the same brand. You can sometimes even get the security deposit waived if you ask. Don’t be afraid to investigate and ask questions about all the fees you see on your lease.
If you get the basics of the lease down, you can make sure you find the best deal out there. Follow these rules and you’ll be sure to get a great lease deal the next time you are in the market for a new car and check back here at the Instamotor blog on the regular for all the new-to-you-car news you need to know.