How To Calculate Your Lease Payments (By Hand)

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Have you ever sat down with a car dealer and zoned out immediately as they began breaking down your monthly lease payments? Well, don’t feel bad!

Many dealers are guilty of convoluting the calculation process, using as many finance terms as possible, and throwing a barrage of numbers at you.

This is an effective tactic to confuse you so you blindly agree to the monthly lease payment. And within that final monthly payment, there can be added services and fees which you don’t necessarily agree with.

Well, the dealer might have one-upped you one last time, but no more.

In this article, we’ll walk you through exactly how a monthly lease payment is calculated including depreciation, financing, sales tax, and other fees. We’ll explain all the terms, give you some pointers, and prepare you for your next lease.

So the next time you lease a new car, you won’t have to depend on the auto dealer’s lease calculator. You’ll be able to negotiate the best possible deal. Let’s get straight to it.

Your total monthly lease payment consists of three factors: depreciation, financing, and sales tax.

Depreciation

Cars are, in general, depreciating assets. This means their value drops continuously with time, starting immediately after you drive it off the lot. Exceptions are some specialty and collector vehicles, which grow more expensive with time.

A brand new vehicle will depreciate by an average of 20% in the first year. This figure may even exceed 30%, depending on the make, model, and market conditions.

After 5 years, a new vehicle will be worth less than half its original value.

When you lease a car and return it after 3 years, you’re giving the leasing company a depreciated asset. It still has a residual value, but the value of the car is worth less than it was 3 years ago.

You’re charged for this depreciation, and the depreciation fee makes up the biggest portion of your monthly lease payment.

To calculate the depreciation fee, we need the adjusted capitalized cost and the residual value of the vehicle.

Net Capital Cost

Net capital cost (a.k.a adjusted capitalized cost) is the money that the finance company pays when they acquire the vehicle for you. It’s the final price of the vehicle after all adjustments have been made.

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These adjustments are added or subtracted from the base price (MSRP) of the vehicle.

Potential adjustments include:

  • MSRP – Manufacturer Suggested Retail Price — the base price.
  • Negotiation – Just like when purchasing with cash, you can negotiate the purchase price of the vehicle when leasing.
  • Rebates – Depending on the make, model, and dealership, there may be a rebate or discount you can use.
  • Incentives – Manufacturers sometimes offer incentives for buying or leasing their products.
  • Down payment – Any cash you offer in advance greatly reduces the net capital cost and your monthly payment.
  • Trade-in equity – The trade-in value of your existing vehicle can be used instead of a down payment, or they can be added together for further capital cost reduction.
  • Loan balance – If you still have some payments on your existing vehicle, the leasing company may offer to pay them off and add the balance to your current lease. This will increase the net capital cost of your new vehicle.

Net Capital Cost Formula

Net capital cost = MSRP – Negotiations – Rebates – Incentives – Down payment – Trade in equity + Loan balance

Not all adjustments will apply for every case. Let’s use a 2020 Audi A6 Premium Plus 3.0T Quattro as an example:

MSRP is $65,600. You negotiate the price of the car down to $65,000 and get a $2,500 incentive. You put another $2,500 as a down payment. You’re returning your existing lease, so you have no trade-in equity nor a loan balance.

Net capital cost = $65,600(MSRP) – $600(Negotiations) – $2,500(Incentive) – $2,500(Down payment) = $60,000

So the net capital cost is $60,000. Next, we need to know the residual value of the vehicle at the end of your lease to calculate the depreciation

Residual Value

The residual value is agreed upon at the beginning of the lease. It typically ranges between 45% and 65% for a 36-month lease.

Leasing companies calculate the residual value for every vehicle based on year, make, model, trim, the lease configuration, and other factors derived from a complicated data analysis. Luxury, high-end models tend to retain higher residual value than economy cars.

The residual value is non-negotiable, but there are ways you can influence it. Other than the vehicle itself, the two biggest factors are the car lease term and the mileage cap.

Car Lease Term

The lease term greatly affects the residual value of the vehicle. A 3 year / 36-month term is standard when leasing.

A longer term will reduce the residual value of the vehicle, increasing the depreciation and depreciation fee. However, your monthly payment could actually get smaller. Even though the sum is larger, it’s spaced out over more monthly payments.

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Mileage Cap

Mileage is a direct measurement of usage. More miles equal more wear and tear, and more wear and tear equals less residual value.

Leases typically come with mileage cap options for 10,000, 12,000 or 15,000 miles per year. The residual value of the vehicle reduces proportionally to your mileage plan.

Carefully consider your driving habits and how the mileage cap will affect your residual value, then choose the appropriate mileage cap. Ask for a custom plan if none of the default options are suitable.

Remember, the leasing company charges you for any extra miles driven upon returning the vehicle at lease end.

Let’s consider our Audi example:

Our 2020 Audi A6 has a net capital cost of $60,000. It is a 3-year / 36-month lease with a mileage cap of 36,000 miles (12,000 miles per year).

Based on the lease configuration, the leasing company sets a residual value of 52% at the end of the lease. 52% of $60,000 is $31,200, so the residual value is $31,200.

Now that we have the capitalized cost and the residual value, we’re ready to calculate the depreciation fee.

Depreciation Fee Formula

The total depreciation is simply the residual value subtracted from the starting price of the vehicle.

Total depreciation = Net capital cost – Residual value

For our Audi example, the total depreciation = $60,000 – $31,200 = $28,800

The depreciation fee (the monthly fee you pay for depreciation) is equal to the total depreciation divided by the number of monthly payments.

Depreciation fee = Total depreciation / Lease term

For our Audi example, the depreciation fee = $28,800 / 36 = $800 per month

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Can You Negotiate the Depreciation Fee?

Yes! Since the depreciation fee accounts for most of your monthly lease payment, concentrate your negotiation efforts here.

You can negotiate the following, which will affect the depreciation fee:

  • The sales price of the vehicle
  • The applied incentives
  • How much trade-in equity your current leased vehicle has
  • The down payment amount you pay (which can be used as leverage)

If your dealership is unwilling to negotiate, don’t be afraid to shop around and see what other dealerships and leasing companies are offering.

Now you understand the first factor in a monthly lease payment: depreciation.

Next, we’ll look at the second factor, which is financing.

Financing

When you start a new lease, your finance provider will purchase the vehicle for the adjusted capitalized cost and rent it to you for the duration of your lease.

You pay for the depreciation, but the leasing company has invested money in an asset that you use. In order to profit, they must charge you interest, just like they would in a traditional loan. So you can think of your car lease as a specialized auto loan.

Depending on who you’re dealing with, you will be provided one of two figures:

  • Annual Percentage Rate (APR)
  • Money factor

They effectively mean the same thing—interest rate. You can convert one to the other using a simple formula and compare.

APR – Annual Percentage Rate

Just like a traditional car loan, the annual percentage rate denotes the interest rate paid on an annual basis.

Additionally, we must acknowledge that auto loans have an interest rate applied to 100% of the vehicle cost, whereas car leases only apply interest to the depreciation amount.

Money Factor

The money factor can be used interchangeably with the APR. It’s the amount of APR paid each month in your monthly payment. It’s used to calculate your financing fee – the fee your leasing company takes as revenue.

To get the money factor, we need to convert the APR from a percentage to a decimal. We do this by dividing the APR by 2400. Or vice versa, you multiply the money factor by 2400 to get the APR. 2400 is a constant number used to convert one to the other.

Money factor = APR / 2400
APR = Money factor * 2400

For our Audi A6 example, let’s say the finance house offers an APR of 10.32%. To calculate our money factor, we simply divide the APR by 2400:

Money factor = 10.32 / 2400 = 0.0043

This is considered a high rate. A low money factor is anything with four zeros – 0.0009 – equivalent to 2.16% APR. APR and money factor are usually higher for new cars and high-end, luxury vehicles.

Choose between loan for car or leasing.

Can You Negotiate the Money Factor?

Unfortunately, no. The money factor is non-negotiable. It’s set by the financial institution for each individual customer.

Your best bet is to shop around different banks and finance providers to see if anyone offers better terms for the vehicle you want. You can also try different lease configurations, trim options, and competitor models to see if you can get a cheaper deal.

That said, you can influence the money factor by reducing the associated risk, which is influenced by your credit score and security deposit.

Credit Score

Credit score plays a huge role in determining the money factor. The better your credit score, the lower the money factor will be, thus the lower your monthly lease payments. Better deals are offered to customers with a FICO score of 700+.

Security Deposit

Unlike renting an apartment, the leasing company doesn’t require you to pay a security deposit. However, you can pay one voluntarily in order to reduce the money factor of your lease.

The security deposit is paid upfront, but it’s not a down payment. When the lease is terminated and there are no additional charges by the leasing company, the deposit is returned to you in full.

Now that we have the money factor, we can calculate the total financing fee for each monthly lease payment.

Financing Fee Formula

Financing fee = ( Net capital cost + Residual value ) * Money factor

For our Audi A6 example :

Financing fee = ($60,000 + $31,200) * 0.0043 = $91,200 * 0.0043 = $392.16

This fee is added to each of your monthly payments and goes directly to the finance company for leasing the vehicle to you.

Sales Tax

The final component of your monthly lease payment is sales tax.

The majority of states set the sales tax rate between 5% and 9% on every purchase. This percentage is added to each monthly payment you make.

Some states don’t have any sales tax, like Alaska, Delaware, Montana, New Hampshire, and Oregon. However, each city and municipality can add its own local tax on goods and purchases.

It’s best to use an online service to check the total tax amount for your location.

For example, using Avalara Sales Tax Calculator with a random San Diego address, we see there are four tax charges applicable to our monthly lease payment:

  • California State Tax – 6%
  • San Diego – 0.25%
  • San Diego CO Local Tax SL – 1%
  • San Diego County District Tax SP – 0.5%

The combined tax rate is 7.75%, which will be added on top of each monthly payment.

Sales Tax Formula

To calculate the sales tax, follow the following formula:

Sales tax fee = Sales tax * ( Depreciation fee + Financing fee) / 100

For our San Diego-based Audi A6 example:

Sales tax fee = 7.75 * ( $800 + $392.16) / 100 = $92.39 – This amount is added to each monthly lease payment.

Some states require you to pay the entire sales tax upfront. If that’s the case, you simply multiply the monthly sales tax fee by the lease term to get the total amount.

Total sales tax = Sales tax fee * Lease term

Total sales tax = $92.39 * 36 = $3,326.04

If the sales tax is paid upfront, it’s excluded from the monthly lease payment entirely.

Can You Negotiate the Sales Tax?

No, the state and local taxes are set and collected by the government and local authorities.

However, if you live near a state border, you can consider making a purchase in a neighboring state, where the taxes may be lower.

Total Monthly Lease Payment

Finally, our total monthly payment is the three components added together.

Total monthly payment = Depreciation fee + Financing fee + Sales tax fee

So, for our Audi example the total monthly payment is as follows:

$800 (Depreciation fee) + $392.16 (Financing fee) +$92.39 (Sales tax) = $1,284.55

One-Time Fees

These fees don’t factor into your monthly payment. It’s paramount to be aware of them before leasing a new car, as they take part in the total cost of ownership.

  • Down payment
  • Security deposit
  • Trade-in charges (for the vehicle you’re returning)
  • Acquisition fees or administrative fees.
  • The first monthly lease payment (due on signing)
  • End-of-lease fees (disposition fee, excess mileage, excess wear, etc).

Some of these fees remain vague, and dishonest dealers can use them to swindle you into paying more than you should.

Acquisition Fee

This is a fee charged by the finance provider for setting up the lease and processing all documentation. It can be called with a different name like:

  • Bank fee
  • Lease inception fee
  • Administrative charge
  • Doc fee / Documentation charge

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It usually varies between $400 and $1000. More expensive vehicles usually have higher fees associated.

The acquisition fee is usually paid upfront, but some leasing companies will allow you to add it in your monthly payments. If so, the sum will be added to the net capital cost of the vehicle and you will pay interest, making the acquisition fee even more expensive.

Some dealers may try to apply a second admin fee under a different name, so be wary and ask what each fee means.

For example, you can negotiate $400 off the MSRP, only to realise later it’s been added back as a documentation fee or anything else.

Disposition Fee

The purpose of this fee is to cover the leasing company’s costs to prepare the vehicle for resale and process the documentation.

Excess wear and mileage

At the end of the lease, your vehicle will be thoroughly inspected against the leasing company’s wear and tear guidelines. Normal wear and deterioration is expected, but excessive wear and damage will be charged a significant penalty.

Similarly, if you go over the agreed mileage cap, the leasing company will charge you a small fee for every mile.

Buyout Price

If you decide you love your car too much, you can pay the buyout price stated in your leasing agreement and make it your own.

Usually, leasing and then buying your vehicle is significantly more expensive than purchasing with an auto loan to begin with.

However, it can save you money depending on the situation. Paying the buyout price avoids the end of lease return process. This means no final inspection, no excess wear charges and no disposition fee.

Early Termination

We won’t go into the details, but you should keep in mind that leasing contracts are typically very strict. Early lease termination suffers heavy penalties and should be avoided at all cost.

So There You Have It

We explained every single fee and charge that forms your monthly lease payment, and the total cost to lease your vehicle.

Make sure to remember the two formulas below:

Monthly payment = Depreciation fee + Financing fee + Sales tax fee
Total lease cost = Monthly payment * Lease term + All one time fees

Now, you can be much more confident when you choose your next leased vehicle. You don’t need to trust the leasing company blindly for calculating your finances for you.

Always shop around multiple dealerships and financial providers to gauge the market around you and make an informed decision.

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