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About That Fine Print

Darwin Beloate

CAR LEASING WILL likely make a comeback in 2023. But is leasing a good idea?

Before the pandemic, leases represented about 30% of new car sales and as much as 70% or 80% for some luxury vehicles. But during the pandemic, with new vehicles in short supply, manufacturers reduced their generous lease subsidies. This, combined with low interest rates, reduced payment differences between financing and leasing, making leasing less attractive.

But that may be about to change. With the average new car price exceeding $48,000, according to Cox Automotive, and interest rates significantly higher than a year ago, leasing could become a more attractive option.

Why take the time to learn the math of leasing? It’s important to be a knowledgeable consumer. When a dealer quotes you a lease payment, how do you know that the price you negotiated for the car is the price on which the payment is based? Some dealers try to negotiate a lease based on the monthly payment and avoid a conversation about the purchase price.

How does leasing work? For a specific term, which is typically 36 months, consumers make a monthly payment and then, at the end of the lease, they return the vehicle to the dealership. Alternatively, at the end of the lease, they can choose to buy the car based on the contracted residual value.

The math behind a lease is fairly simple. It’s the vehicle’s projected monthly depreciation plus the monthly interest. The depreciation varies by make, model and trim. To make the depreciation calculation scalable based on a car’s price, the financing arm of car manufacturers express a vehicle’s residual value at the end of a lease as a percentage of the MSRP, or manufacturer suggested retail price. It’s frequently in the 50% range for a 36-month term.

Cars with good resale values have higher residual values. That translates to less depreciation and hence lower lease payments. Say a vehicle with a $44,000 MSRP has a 55% residual value. That works out to $24,200. If you subtract the $24,200 residual value from the $44,000 negotiated sales price, which I’m assuming is the same as the MSRP, you get $19,800 in projected depreciation. Divide the projected depreciation by the 36-month lease term, and you get $550 in monthly depreciation.

Next, we need to calculate the monthly interest charge. This starts with the capitalized cost, which is basically the amount being financed. Capitalized cost is the negotiated sale price, plus the lender’s lease acquisition fee and any dealer fees, minus the down payment. For instance, in our example, if it’s a zero-down-payment lease, the capitalized cost would be the $44,000 negotiated price, plus perhaps a $650 lease acquisition fee, plus maybe $400 in dealer fees, for a total of $45,050.

The capitalized cost is added to the residual value, and then multiplied by the money factor. The money factor is the interest rate for a lease. Using our example, you’d add the $45,050 to the $24,200, and then multiply by the 0.0025 money factor.  That results in $173.13 in monthly interest. (It might seem like you’re charged interest twice on the car’s residual value—after all, that residual value is also included in the negotiated price—but the money factor adjusts for this perceived double counting.)

If you add the monthly interest payment to the monthly depreciation, you get the lease payment, which in this case would be $550 plus $173.13, or $723.13 total. Want to convert the money factor into an interest rate? You multiply the money factor by 2,400. Thus, a money factor of 0.0025 is equal to a 6% interest rate.

For simplicity, I have left taxes out of the equation. In most states, the sales tax is calculated on the monthly payment and not on the sales price of the vehicle at the time of leasing. This tax deferral is seen as another advantage of leasing.

According to a study done by CNW Marketing, the top three reasons consumers lease are lower monthly payments, smaller down payments and the chance to drive a nicer car for the same monthly payment. Meanwhile, the top complaints about leasing are the penalties at the end of a lease for exceeding mileage allowances and for wear and tear, the fact that you don’t build any equity, and the cost to exit a lease prior to the lease’s scheduled maturity.

Meanwhile, why do car manufacturers like leases? There are three main reasons:

  • By subsidizing leases, car companies can boost sales volume.
  • Leases allow car makers to maintain a relationship with consumers, with the potential to sell them vehicles every three years. By contrast, buyers typically go longer between car purchases.
  • As cars come off lease, they provide a steady supply of three-year-old cars for dealer’s used car operations and create a more affordable alternative for entry-level buyers.

Is leasing a wise move? It depends on your circumstance. If you buy cars and keep them for a decade, leasing is not the right route. But if you plan on getting a new set of wheels every three years, it might be worth considering.

Darwin Beloate spent 35 years in the automotive industry. He started working at an Isuzu dealer in Marietta, Georgia, while in high school and worked for car dealers in parts, service and sales throughout college. In 1990, he graduated from Northwood University with a degree in automotive marketing and worked for Nissan North America in marketing and sales positions for 30 years. He’s been a real estate investor since 2015 and, in his spare time, enjoys track days in his 1994 Mazda Miata R type.

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