Auto Leasing
Decompose how auto leasing works. Create software and tools to simplify the process. Leverage my knowledge to help others.
Result is a thorough understanding of auto leasing, with enough knowledge to help others.
Overview
I was interested in leasing a vehicle but the numbers didn't make sense to me. Meaning, I wasn't able to follow the trail from the vehicle price to the monthly lease payment.
That curiosity turned into a research project to understand the economics of leasing and how to structure a fair deal.
When you buy an automobile there are three finance options:
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Purchase - buy the vehicle with a single payment, i.e., write a check.
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Finance - finance the purchase, i.e., monthly payments typically financed by another party (bank, credit union, etc.).
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Lease - payments based on purchase price and residual value (a detailed explanation is below).
Options 1 and 2 are easy. A single payment or monthly payments based on the purchase price and the interest rate. Basically, a single Excel formula.
For example, the formula for a $30,000 loan at 7% interest for 60 months is:
=PMT(0.07/12, 60, 30000), which is $594.04 per month.
Option 3, leasing, requires a deep dive to understand financing, how deals are structured, and how to make the numbers work for you.
The problem
A lease has many variables that determine the monthly payment.
The MSRP (Manufacturer's Suggested Retail Price)
Also known as the window sticker price. The MSRP determines the vehicle value at the end of the lease period.
The negotiated price
This is discount you negotiate from the MSRP. During the pandemic, when there was a shortage of vehicles, there are no discounts, just markups.
Manufacturer discounts, incentives, and rebates
Manufacturers issue discounts, incentives, or rebates as a means of discounting the final price in order to increase sales. The amounts vary by region and eligibility. For example, college graduates and members of the military often qualify for incentives.
Some terms you may run across are conquest and loyalty. A conquest incentive entices the customer to switch from a competing brand (Audi, Ford, GMC, Lexus, etc.) to their brand (Jeep, for instance). A loyalty incentive entices the customer to remain with the brand.
Down payment
An up-front payment used to lower the monthly payment. When comparing leases, always use a down payment of $0 (zero) so you can compare deals, dollar-for-dollar.
During inflationary times you want to defer payments as long as possible. A dollar today is one dollar. A dollar in the future is worth less due to inflation. Also, there have been cases where someone leases a vehicle, makes a down payment, and has an accident shortly thereafter. The insurance company pays off the balance and the down payment is not recovered.
Lease term
Typical lease terms are typically 24 or 36 months. If you're fixated on the monthly cost then the dealer can extend the terms to 39 or 48 months, effectively lowering the monthly payment but increasing the overall cost.
Sometimes, not often, you will find great deals on 18, 24-month, or 27-month leases with high residual values (see example, below). These are often found at the end of a year when the manufacturer decreases the lease term (from 36 to 24 months) and artificially raises the residual value (from 65% to 72%, for example) to incentive dealers to move (sell) inventory.
Miles per year
The residual value (how much the vehicle is worth at the end of the lease) is based on the lease term and miles driven per year. A vehicle is worth more after 24 months than 36 months. And one driven 10,000 miles/year is worth more than driving 12,000 miles/year.
As you increase the lease term (in months) and the miles per year, you decrease the residual value (what the vehicle is worth at the end of the lease).
Residual value
The residual value is set by the manufacturer and cannot be changed. This is one of the few numbers that can't be changed. The residual value is determined by the lease term (in months) and the number of miles driven per year.
The residual value is expressed as a percent. For example, a residual value of .72 means the vehicle is worth 72% of the MSRP at the end of the lease.
For example, a Jeep Grand Cherokee leased for 24 months and driven 10,000 miles/year had a residual value of 72%. If you select 12,000 miles/year the residual value decreases to 71%.
When you lease, you are paying the difference between the negotiated price and the residual value.
Depreciation amount
When leasing you pay for the amount of the vehicle that's depreciated (the difference between the MSRP price and the residual value.)
For example, you lease a vehicle with a $50,000 MSRP for 36 months and a residual value of 65%. The residual value, at the end of 36 months, is $32,500 ($50,000 * 65%). You are paying $17,500 ($50,000 MSRP - $32,500 residual) over 3 years, which is $486.11/month.
Money factor
When you lease a vehicle you pay a finance charge, which includes an interest rate. This is similar to financing a vehicle. The monthly payment is based on the purchase price and the interest rate.
The money factor is expressed as a small number. Multiple the money factor by 24 and you get the APR (Annual Percentage Rate). For example, a money rate of 0.00141 is a 3.384% APR interest rate (0.00141 * 24 = .03384, which is 3.384%).
Finance amount (rent charge)
The finance amount is called the "rent charge" in the auto business. To calculate the average monthly rent charge, the money factor is multiplied by the sum of the purchase price and the residual value.
For example. You buy a $50,000 (MSRP) vehicle, negotiate a $3,000 discount, and receive $2,000 in incentives. The purchase price is $45,000. The residual value is 65% based on a 36 month lease with 10,000 miles/year. The residual amount is $32,500 ($50,000 MSRP * 65% = $32,500).
Purchase price ($45,000) plus residual value ($32,500) is $77,500. Using a money factor of 0.00141 (3.384%) results in a monthly rent amount of $109.28 ($77,500 * 0.00141).
Due at signing fees
The above calculates the monthly lease payment. The first payment, often known as "due at signing," includes other fees. Let's take a quick look at them.
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First payment - same as the monthly lease payment
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Acquisition fee - a fee the manufacturer changes, $595 is common
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Dealer fee - covers their time, paperwork, credit application fees, etc.
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Government fees - varies by city and state
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Tax - how a lease is taxed varies by state, some roll taxes into the monthly payment, others collect taxes upfront
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Title - There is a fee to issue a vehicle title
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License - and more fees for license plates
Dealer add-ons
One dealer I dealt with had numbers that were $25/month more than my calculations. It took days before I was able to get an explanation.
They added $25/month as a payment for the sales person. $25 wasn't disclosed. There were so many line items that you couldn't add them in your head. Yet the total number was $25 off. Buyer beware.
Lease insights
Get a detailed explanation of the calculations and fees. Calculate your own fees or use a good online lease calculator. I like LeaseHackr.com.
Create a spreadsheet to make sure they numbers add up (see dealer add-ons, above).
Remember, a change in any of the above numbers affects the monthly lease amount and the amount due at signing.
If the dealer is pushing you for a target monthly rate, such as $500/month, then the dealer is able to manipulate the numbers to give them the maximum profit at your expense. The goal is to understand what the numbers mean and how to make a deal work for you.
An example
Let's go through an example and explain the numbers in detail.
The vehicle I choose is a 2023 Jeep Grand Cherokee Limited L (3-row).
The lease term is 24 months and 12,000 miles/year. The residual is 71%.
The money factor is 0.00201, which is 4.824% APR.
| Category | Item | Amount | Description |
|---|---|---|---|
| Price | |||
| Base price | $51,855 | Base price before destination fee and options | |
| Destination | $1,795 | Destination charges | |
| Options | |||
| Black package | $2,240 | Black appearance package, wheels, accents, etc. | |
| Luxury Group II | $2,440 | Safety features and cold weather package | |
| Paint | $495 | Pearl-coat paint | |
| Trailer tow | $695 | Towing and engine cooling | |
| Total Options | $5,870 | ||
| MSRP | |||
| MSRP | $59,520 | Base price + destination + options | |
| Lease | |||
| MSRP | $59,520 | Base price + destination + options | |
| Discount | $2,262 | Dealer discount, 3.8% | |
| Selling price | $57,258 | Price the dealer sells it for (MSRP - discount) | |
| Incentives | $5,500 | Manufacturer incentives | |
| Purchase price | $51,758 | Price you purchased it for (selling price - incentives) | |
| Discount | 13.04% | Effective savings from MSRP | |
| Depreciation | |||
| Residual pct | 71% | Residual percent after 24 months | |
| Residual value | $42,259 | Residual value after 24 months (MSRP $59,520 * 71%) | |
| Depreciation | $9,499 | Depreciation amount over 24 months ($396 / month) | |
| Finance | |||
| Purchase price | $51,758 | Finance purchase price | |
| Residual value | $42,259 | Finance residual value | |
| Total financed | $94,017 | Finance total | |
| Money factor 0.00201 | $189 | Finance charge per month ($94,017 * 0.00201) | |
| Monthly | |||
| Months | 24 | 24 month lease | |
| Depreciation | $396 | Depreciation per month ($9,499 / 24 months) | |
| Rent | $189 | Rent (finance) charge per month | |
| Total | $585 | Lease payment per month (depreciation + rent) | |
| Due at signing | |||
| First month | $585 | First month payment | |
| Down payment | $- | No reduction in monthly lease payments | |
| Fee - acquisition | $595 | Manufacturer fee | |
| Fee - docs | Dealer fee | ||
| Fee - other | |||
| Taxes | $1,750 | License, registration, tax, and title | |
| Total | $2,930 | Amount due at signing (first month + down + fees + taxes) | |
| Per month | $122 | If paid over the 24 month lease | |
| Total | $707 | Effective monthly payment ($585 lease + $122 due at signing) |