How Car Lease Payments are Calculated

how to break car lease

by FrugalTrader on November 23, 2009

With the new 2010 Honda CRV released, a renewed interest in a replacement vehicle has occurred in our household. After browsing around the auto makers website, I was curious as to the difference between purchase and lease payments. As someone who likes to pay cash for everything to avoid the interest, I’ll reluctantly admit that leasing does have a certain appeal as it reduces the monthly payments.

One thing that caught my eye on the lease payment calculator was that the monthly payment was higher than I had expected. As a lease is basically paying for the depreciation of a vehicle, I assumed that the interest rate quoted is applied to the purchase price minus the end value. However, using a simple loan calculator, the numbers don’t match.

So after some digging, I figured out why my calculations were off. The lease payments are calculated a bit different where the deprecation AND lease fee must be paid for.

What is a lease fee?  Basically, the formula is:

Lease Fee = (Purchase price + Residual Value) * Money Factor

Money Factor = Interest rate on the lease payment divided by 2400.

Lets do an example on the Honda CRV and pretend for a moment that I pay full price for the vehicle.

  • MSRP + freight/PDI: $29,880
  • Residual Value: $15,276.60 (after 3 years)
  • Depreciation over 3 years: $14,603.40 ($405.65/month)
  • Annual Lease Rate: 4.9%
  • Money Factor = 4.9/2400 = 0.00204
  • Lease Fee = ($29,880+15,276.60) * 0.00204 = $92.12/month
  • Lease Payment = $405.65 + $92.12 = $497.77/month * sales tax

As you can see, before sales tax, the payment is approximately $498/month which is higher than having

a loan (@4.9%) for the depreciation only which would work out to be around $437/month.  In fact, paying $498/month is basically paying 4.9% on $16,640 instead of the stated deprecation $14,603.

In other words, the $498/month payment represents a 14.2% interest rate on the depreciation over 3 years.

When it comes down to it the important thing is to look at the big picture when comparing purchasing and leasing.  Ask yourself, what is the total cost of the vehicle after accounting for the payments, sales tax and other fees?

In this example, assuming that the leased CRV is bought out after the 3 years, the total cost of the vehicle would be around $37,740  However, if this vehicle is financed over 3 years at the same 4.9%, the total cost would be $36,488 (with $0 down, but double the monthly payments).  A difference of around $1,250 with both at the same interest rate.

The benefit of a lease is obvious, lower monthly payments and the “benefit” of returning the vehicle after the term.  However, the lower payments usually result in a higher overall cost in the end.

If you’re interested, here is a previous article on how to reduce your car lease payments .

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Where does that 2400 number come from? Is it some sort of rule of thumb?

Mike Kolcun November 23, 2009, 10:45 am

Thanks for the post, We recently decided to purchase a used vehicle, we ended up getting a 2007 model (the 2010 model was available new) with 40k km on it.

Source: www.milliondollarjourney.com

Category: Credit

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