Understanding Car Lease Equation

I went through car lease process recently and want to share my knowledge. First step: understanding the monthly lease cost equation.

I will go over the major variables that affect the monthly lease price: MSRP, net capitalization, residual value, lease length, and money factor, what they are and give an example of calculation.

After reading this, you will know the “variables” that affect your monthly lease price on your current or future car.

This article will take you about five minutes to read.

Introduction

I leased every one of my cars yet, I never understood the variables that went into calculating the lease price.

My sister forwarded this article that describes the equation that calculates the lease price.

  Net Capitalization - (MSRP * residual value) / number of months 
+ Net Capitalization + (MSRP * residual value) * money factor

Where:

Simple, right?!

MSRP

This is short for: Manufacturer’s Suggested Retail Price.

It is the price of the car on the market set by the manufacturer. For the life of the car, it will have this price for this year, next year, etc.

The car’s class and configuration (packages, options, etc.) affects MSRP.

In the monthly lease equation, MSRP directly affects the “value” of the car. The cheaper the car, the lower the monthly payments. The more expensive a car, the higher the monthly payments.

You can control the MSRP in the lease equation by choosing different car class and configurations. From the debut of a car, the manufacturer sets the car’s MSRP.

Net Capitalization

This is the final cost you pay for the car after any discounts used from the MSRP.

Net Capitalization directly affects how the lease value of the car and is the main variable you have control over the monthly price in a lease. Like MSRP, the higher the net capitalization, the higher the monthly payments. The lower the net capitalization, the lower the monthly payments.

You have control over the net capitalization in the lease equation by:

• down payments
• security payments

The manufacturer and dealer controls the net capitalization by:

• manufacturer’s incentives
• dealer discounts

I’ll go over each of these by who controls these levers: consumer and manufacturer.

Customer Levers

Of the consumer levers, the one that is most known is the down payment and security deposit is basically a secret.

Both have are payments a customer can make to reduce the total cost of the car, lowering net capitalization. By having a lower net capitalization, the monthly lease is lower.

It’s up to you how much down payment or security deposit to apply to the net capitalization.

The larger the down payment or security deposit, the lower the monthly lease payments.

Down Payment vs Security Deposit

The BIG difference between the two payment types:

• Down Payment: gone as soon as the lease starts
• Security Deposit: comes back at the end of the lease

Never put a down payment, always a security payment. I’ve learned the hard way and will never put a down payment for a lease again. 💸

Manufacturer/Dealer Levers

A manufacturer can also provide incentives to lower the price of a vehicle without affecting the MSRP!

Some incentives buying or leasing a car:

• Loyalty - if you are trading in a leased car from the same manufacturer
• New Grad - if you just graduated school, there’s a good chance it’s your first car
• Business Partner - car manufacturers also provide additional benefits for any companies that work with them
• Veterans - if you served in the military

There are more, it depends on the manufacturer, the timing, market conditions, etc. It helps to ask what “incentives” there are and what are those requirements.

You can control which incentives apply by being in the right market for an manufacturer incentive.

Dealer Discount

One thing you always hear: buy a car at the end of the month and/or year.

Yes, a dealer can provide their own discounts at their discretion. The main motivation for dealer discounts: sales quotas.

If you want a car that is overflowing the dealer’s inventory, they will be more motivated to provide a discount.

Residual Value

The next variable in the monthly lease equation: residual value (aka: RV). Basically, the depreciation of the car over time.

Residual value is a percentage of what the value of the car will be at the end of the lease period based on the original MSRP.

The manufacturer determines a car’s residual value. This may be the most objective way to say what car “holds it’s value” the best.

To get a car’s residual value it is publicly available from dealerships. I found it through the Edmunds’ Car Forum for my specific make, model, configuration, and dealer area.

As a consumer, you want a higher residual value because it will lower your lease payments.

Money Factor

The money factor variable, MF, is the interest rate the manufacturer charges in loaning you the money for the car.

The lower the interest rate, the cheaper the cost of the loan is to you.

Like Residual Value, it is publicly available from the dealers and on forum sites. Money Factor depends on the make, model, configuration, and dealer area.

As a consumer, you want a lower money factor as it will lower your lease payments.

Lease Length

The lease length is the number of months the car of the leasing period.

The lease length will affect the residual value and money factor.

As a consumer, you have direct control over the lease length. At the same time, manufacturers usually give 24 or 36 month leases with 36 months the sweet spot.

Example

Applying numbers to the equation will help illustrate how just the purchase price affect lease payments on a BMW M4.

I got my values above for an M4 from Edmunds’ Car forum.

Let’s plug the values from above into the lease equation:

Net Cap - (MSRP * residual value) / number of months

• Net Cap + (MSRP * residual value) * money factor = Monthly lease payment

I did the calculation for how changes in the net capitalization cost can affect the monthly lease payment amounts in three scenarios:

• Paying only the MSRP
• Using dealer incentives
• Using dealer incentives and negotiating a dealer discount

I separate out the purchase price as a way to show that is a lever a you have control over (i.e. not using a down payment!)

Note, this does not have taxes involved. States charge taxes differently depending on its laws.

Conclusion

Understanding the main variables in the car lease equation help me understand what levers you, the manufacturer, and the dealer have at their disposal. I hope this helps you, especially if you’re in the market.

The important part for you as a consumer is that choosing the right car for you and getting the lowest purchase price (without a down payment!). These are the real levers you have to work with in lowering your monthly lease payments.

If you’re looking to learn more about leasing a car, please contact me and I can share my experience.