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 If you're new to car leases or if you've leased a car in the past then you've probably read or heard the term money factor. If you don't know what the money factor is then keep on reading because we're going to explain how this value is used in calculating car lease payments.
In this article we're going to first run through the fundamental concepts of car leases. We'll explain how they work, how the car dealership makes money, and provide you with a couple of simple steps you can take to figure out if the monthly lease payment you're being offered is a fair one.
That discussion will naturally lead us to the calculation of lease payments - and that's where you can see how the money factor is used. We'll even provide you with links to our online car lease calculators as well as a car lease spreadsheet that you can download.
Car Leases and the Money Factor
Conceptually, a car lease isn't very different than buying a car and selling it in a couple of years. You pay for a brand new car, drive it around for a while, and then sell the car. During that time you used up some of the car's value - it's now worth less then when it was new.
This lost value is a very important concept to understand because along with the money factor these are the two most important variables that consumers need to understand when leasing a car.
Calculating Monthly Car Lease Payments
Most cars can be driven virtually forever - as long as you've got money to pay for repairs. But as cars age these repairs become more expensive and frequent. When a car reaches this point it is said to be at the end of its useful, or serviceable, life. All of the value has been extracted from the vehicle. This is the concept behind depreciation.
Car Depreciation Expense
When a car dealership calculates monthly lease payments, the need to understand the depreciation in value the car will experience. They need to be able to accurately predict how much the car is worth at the end of the lease.
Since most car leases are relatively short in duration - 24 to 48 months - one of the best indicators of depreciation is the age of the vehicle and the number of miles the car was driven. This is the reason a car lease usually specifies an annual mileage cap - to help control depreciation.
Cost of Borrowing Money
When you lease a car you never really take ownership of the vehicle. You're only borrowing it; the dealership still owns the car. And since the dealership is allowing you to take possession of a $30,000 asset and pay for its use over time via monthly lease payments they're assuming the risk of non-payment (it happens) and they're losing an opportunity cost - they could be using the money they paid for the car and investing it elsewhere.
Money Factor Calculation
This is where the concept of the monthly finance fee, or money factor, comes into play. As mentioned earlier, the money factor compensates the car dealership, or lender, because they're taking on a risk of non-payment and they're losing an opportunity to invest the money they've paid for the car you're leasing.
In fact, the money factor is directly comparable to the Annual Percentage Rate, or APR, you'd see when shopping around for a car loan. The two simple formulas below demonstrate the relationship between money factor and interest rates:
- Interest Rate = Money Factor x 2400
- Money Factor = Interest Rate / 2400
Car Lease Example
To better understand how depreciation and money factor affect monthly car lease payments let's run through a quick example:
In this example, let's assume you're going to lease an Audi A4 Quattro with a MSRP of $32,000. Furthermore, let's also assume that you're able to negotiate a Base Capitalized Cost (Base Cap Cost) of $30,000.
To calculate how much "money" is involved with this lease, you've also got to add in dealer acquisition fees (around $750) and any extended warranties ($2,000 in this example). So we've got a total of $32,750 in Gross Capitalized Costs.
Next up let's try to lower the amount of capital (money) involved by trading in a car for $3,000 and using a down payment of $3,200. So our net capitalized cost is now only $26,550. Finally, let's also assume the car's residual value is $16,000 after three years.
If we ignore sales tax, then the lease payment would be the sum of the depreciation plus the finance, or rent charge. Depreciation is the difference between the net capitalized cost and the residual value which is $10,550 in this example.
Rent or Finance Charge
The rent or finance charges is just that - how much it's going to cost you to finance the car. We know how much you must pay for the car's lost value ($10,550) and here is where the money factor comes into play.
The rent or finance charge is calculated using the following formula:
Rent / Finance Charge = (Net Cap Cost + Residual Value) x Money Factor x Lease Term
Going back to our example now, if we assume the money factor is equal to 0.00292 (which is equivalent to an APR of 0.00292 x 2400 = 7.0%) then the total of our finance charge is $4,472.86. If we add this charge to the depreciation then we need to collect $15,022.86 over 36 months which works out to be $417.30 per month.
Getting a Good Deal on a Car Lease
We hope it's clear from the above example that it's not so easy to figure out if you're getting a good deal on a car lease. We can help simplify the steps in calculating if you're getting a good deal by assuming the residual value is a fair price. After all you usually have the option of purchasing the car for its residual value at the end of the lease so the dealership likes to keep that number as accurate as possible.
If you're good at negotiating or you've done your homework before negotiating with the dealer then you should also have a pretty good idea of what's a fair price or base capitalized cost to pay for the car. Both of these two items have the depreciation charge covered.
With the depreciation charge behind us, there is only one other piece of information you need to know to make sure you're getting a good deal on a car lease. You need to understand the finance or rent charge which brings us back to the money factor once again.
Car Lease Calculations
Unless you're great with numbers then you're going to have to ask the dealership for the money factor or you need to be able to calculate the money factor from the finance charge appearing on the lease contract. The easiest way to figure out the factor is simply asking the dealership for the number and multiplying that value by 2400. When quoting the money factor some dealerships might quote a value like 2.92 instead of 0.00292. If they quote the money factor this way then just multiply the value by 2.4.
Once you calculate the interest rate from the money factor all you need to know is if that rate is competitive in today's marketplace for someone with your credit rating. If it is then you're probably getting a fair deal on the car lease.
Car Calculators
If you're interested in doing some more detailed calculations then be sure to check our complete line of car loan calculators. There you'll even find a lease or buy a car calculator if your not sure what's the best route to go.
Finally, if you're interested in learning more about money factors and car leases, then be sure to read our publication on car lease calculators. There you'll find a complete set of instructions on how to use a car lease spreadsheet that you can download to your home computer and use whenever you need to evaluate a car lease.
About the Author - Money Factors in Car Leases
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