MM Money

Leasing Demystified

THE FIRST THING to understand is that leasing is not renting. When you lease a car, you are arranging for the vehicle to be sold to a leasing company -- usually an arm of the manufacturer. The leasing company then lets you use it for a monthly fee over a set period of time, typically two to four years. (There is no limit, however.) When the term of the lease is up, you have the option: You can return the car to the dealer and walk away without paying anything else. Or you can buy the car for a prearranged lump sum, which is known as the vehicle's "residual value." (Click here for a full glossary of leasing terms.)
That's simple enough. What complicates things is the number of factors that go into calculating the monthly payment. When you lease a car, what you are paying for is the car's depreciation over the term of the contract, plus interest, taxes and fees. Depreciation is the difference between the car's value today (the price) and what it will be worth at the end of the lease (the prearranged residual value). As in a sale, the price (known in leasing as the capitalized cost) is negotiable. It can be cut automatically with a down payment or a trade-in. You can also negotiate the upfront costs, such as the acquisition fee and security deposit, to get a better deal.

Who Thought This Up?
Only after all those numbers are set can you calculate the monthly payment. Given a two-year lease, for example, the depreciation is the difference between the price negotiated today and the prearranged residual value 24 months from now. You then subtract any down payment or trade-in.

To calculate the monthly payment, you then take 1/24 of the depreciation, add in 1/24 of the total interest on the financing, and then add 1/24 of the sales tax, which is usually paid monthly instead of upfront.