The three elements of a lease payment
A lease payment is generated primarily from three elements: the Cap-Cost (the price), the Residual (value of the vehicle at the end of the lease), and the Money-Factor (comparable to an interest rate). Each one of these elements will affect the payment in a different way.
The cap-cost element is self-explanatory: the lower the price, the lower the payment. However, the residual and money-factor can affect the lease differently. The easiest way to look at the relationship between the residual and money-factor is to look at it from the leasing company’s (bank’s) perspective. The residual is the amount that the bank is obligated to pay for the vehicle at the end of the lease, while the money-factor is used to calculate how much money they are making on each payment.
If a leasing company would like to make the most money over the Term of the lease, it would apply a high money-factor. Conversely, if the leasing company would like to own the vehicle at the end of the lease at a good price, they would use a low residual.
For example, a bank could set the residual at a low value that would enable them to sell it easily or for a profit. This means a lease can have different money factors and residuals for the same payment.
Let’s look at two different scenarios based on the same cap-cost (price) and term (number of months). These examples will have different residuals and money-factors and yet they will yield the same payment of $318.
This example will be based on a price (cap-cost) of $20,000 and a 36 month (3 year) lease.
The Residual is $12,000, which produces a balance of $8,000 (the depreciation).
$8,000 divided by 36 months is $222 per month. Therefore, $222 of each lease payment is depreciation.
The Money-factor is 0.00300, which will yield a lease charge of $96.
The Total Payment is $222 + $96 = $318
The Residual is now a lower value of $10,000, producing a balance of $10,000.
$10,000 divided by 36 months is $277 per month. Therefore, $277 of each lease payment is depreciation.
The Money-factor is 0.00135, which will yield a lease charge of $41.
Therefore; $41 of each lease payment is the lease charge. The Total Payment is $277 + $41 = $318
In the first scenario, the residual is $12,000, indicating that the bank will own the vehicle for $12,000 at the end of the lease. This amount could be more than the car is worth in 3 years. Therefore, the leasing company is charging $96 on each payment.
In the second scenario, the Residual is $10,000, indicating that the bank will own the vehicle for $10,000 at the end of the lease. This could be exactly what the car will be worth in 3 years, so the bank is only making $41 on each payment. In the first scenario, the bank charged approximately $2,000 more in lease charges over 3 years than it did in the second scenario. However, in the second scenario, the bank will own the vehicle at the end of the lease for only $10,000, which is $2,000 less than in the first scenario.
If all this doesn’t affect the customer’s payment, why should the customer care? The reason is that if the customer is considering purchasing the car for the residual value at the end of the lease, he should look for a lease with a low residual, as in the second scenario. In this scenario, most of his lease payment is going to “pay-down” the value of the car and less is going to the lease charge. It is important to look carefully at all the components of the lease. It is wise for the customer to request the residual value and money-factor of every lease payment quoted by the dealer. The guidebook’s printable “Leasing Cheat Sheet” will allow the customer to verify the actual cost of leasing and select the best option. Also, because money-factors are not disclosed on a lease agreement, you can use our Money-Factor Finder to discover these values.