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Capitalized cost, gross capital, cap cost reduction—You hear these terms every time you shop for a new leased vehicle. But do you really know what they mean?
The dealer performs their little dance, throwing out a whirlwind of numbers and finance terms. And you just sit there waiting for them to finish, because all you need to care about is the size of the monthly lease payment, right? Wrong!
By leaving yourself at the mercy of the dealership or leasing company, you’re always going to pay more for your lease.
That’s why it’s imperative to know the components that form your final monthly lease payment, like capitalized cost, gross cap cost, and net capitalized cost. Understanding these elements gives you the opportunity to negotiate the lease contract, attack the price from different angles, and secure the best deal possible.
Arguably the most important component of your new car lease is the capitalized cost.
The capitalized cost is the negotiated price of the car. It is the purchase price agreed upon by you and your car dealer. Sometimes it’s called the “lease price,” and it tends to be lower than the car’s manufacturer’s suggested retail price (MSRP).
Everything else in your lease, including your monthly payment, is based on the vehicle’s capitalized cost, so it’s paramount to secure the lowest possible price.
Capitalized cost has two ways it can be referenced: gross capitalized cost and net capitalized cost.
The gross capitalized cost includes the negotiated price of the car as well as fees and taxes associated with the lease agreement. The net capitalized cost is the gross cap cost after any applicable rebates and cost reductions. The net cap cost is the final price of the vehicle, and it forms your monthly lease payment.
Let’s see how the gross and net capitalized cost are formed in more detail.
Gross Capitalized Cost
The gross capitalized cost is the sale price of the leased car. It includes the capitalized cost along with all other financed costs.
The latter refers to taxes and fees, like the acquisition fee, sales tax, security deposit, disposition fee, and trade-in credit, among other smaller costs. Depending on your lease, these can be due up front or rolled into the gross capitalized cost and broken down into each monthly lease payment over the term of the lease.
If all fees and taxes are deferred into your lease payments, the lease is said to have “0 out-of-pocket expense”. The obvious benefit is not parting with a large sum of cash. However, you should always keep in mind that a higher gross capitalized cost makes the total lease more expensive.
Some leases come with some fees paid upfront and others added into the monthly payments.
Gross Cap Cost = MSRP + Acquisition Fee + Sales Tax + Trade-In Credit + Other Fees
The acquisition fee is charged to set up a new lease with the financing company. It covers paperwork and administration associated with the lease.
The acquisition fee is usually a few hundred dollars and is due upfront. However, it can be added to the capitalized cost and broken down into the monthly payment.
The sales tax is a community or state-enforced charge on purchases of goods and services. It’s applicable to leased vehicles and can be paid upfront or added to the capitalized cost and rolled into the monthly payment.
In the states of Texas, New York, Minnesota, Ohio, Georgia, and Illinois, the entire sales tax is due immediately after signing the lease contract. In this situation, the financing company usually offers to roll the sales tax into the capitalized cost of the vehicle, preventing a large upfront cash payment.
The trade-in credit is the total amount you owe the leasing company for the remaining months of your current lease. It’s only applicable if you’re trading in your current leased vehicle for a new leased vehicle.
Sometimes, the leasing company will allow you to exit your current lease earlier than its termination date (usually called early termination) and jump into a new car lease.
In this case, the trade-in credit left on your old vehicle is added into the capitalized cost of the new lease and then broken down into the monthly payments.
Additional costs like auto insurance, GAP insurance, and license and registration fees can also be a part of the gross cap cost.
Net Capitalized Cost
The net capitalized cost (also known as the adjusted capitalized cost) is the final selling price of the vehicle.
It’s equal to the gross capitalized cost minus all rebates, incentives, and upfront capital that you invest into the leased vehicle. These items that reduce the gross capitalized cost are cumulatively referred to as “capitalized cost reduction.”
Net Cap Cost = Gross Cap Cost – Cap Cost Reduction
Cap Cost Reduction = Trade-in equity + Down Payment + Rebates & Incentives
Let’s look at each capitalized cost reduction in more detail.
Trade-in equity is the value of a vehicle that you personally own. If you have one, you can trade it in for a new leased vehicle and use its value to offset a big portion of the cost.
If you’re trading in your car, the leasing company will calculate its equity by looking at its current market price and condition. The trade-in equity will then be subtracted from the gross capitalized cost.
You should be wary of how your vehicle is appraised. Many times, you can get a higher price selling your vehicle elsewhere and still use the cash as a down payment for your new leased vehicle.
A down payment is a large sum of cash that is paid upfront in order to reduce the capitalized cost of the vehicle. It is not always required, and usually, the customer decides the amount of money to put down.
If you do agree to place a down payment, it’s directly subtracted from the gross capitalized cost to massively reduce the total cost of the lease. You can also use your trade-in equity as a down payment or sometimes in conjunction with it.
Rebates & Incentives
Rebates and incentives are manufacturer-issued discounts to encourage more people to lease particular vehicles from their line up.
Rebates are usually offered on previous-year models or at the end of the current model year. By offering these lease deals, manufacturers try to sell all their remaining stock. The amount can be sizable—up to a few thousand dollars—so it’s a good idea to look for them.
Remember, the net capitalized cost is the final acquisition price of the leased vehicle. Everything in your lease, including your monthly payment, is derived from the net capitalized cost.
Residual Value and Depreciation
Finally, we need to talk about residual value and depreciation.
The residual value is the remaining value of the car at the end of the lease. It’s a percentage of the net capitalized cost, and it’s predetermined by the leasing company.
The residual value is non-negotiable and usually ranges around 50% for a 3-year lease. Customers can influence it by configuring their lease duration and mileage cap.
The depreciation is the difference between the net capitalized cost and the residual value. You want a higher residual value because you want a lower vehicle depreciation.
Depreciation = Net Capitalized Cost – Residual Value
When leasing a new vehicle, you’re really paying for its depreciation. Essentially you’re borrowing a car loan for the depreciation amount, and that loan comes with an interest rate.
When you divide the depreciation amount by the number of months in your lease term, you get the so-called “rent charge.” Everything that makes it into the depreciation accumulates interest, either in the form of an ARP or money factor. From there, sales tax is charged on the depreciation and the interest portions of your monthly lease payment.
It All Starts With Capitalized Cost
A smaller net capitalized cost and a higher residual value reduce the total lease cost, thereby reducing the size of your monthly lease payments.
If you want lower monthly payments, you need to negotiate the lowest possible net cap cost.
And if you’re looking to secure a better deal on your new car lease, contact Below Invoice today!