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Understanding Lease Terminology

Before stepping into a dealership to lease a car, it’s important to understand lease terminology to make sure you get the best deal possible and aren’t taken advantage of by a dealer.

Understanding the basics

Cars are often advertised with much lower payments for leases than for purchases. According to a February 2012 article from J.D. Power and Associates contributed by Jeff Youngs, this is because lease payments are based on the depreciation value of the vehicle during the contracted term of operation.

There are, however, additional terms and fees on top of the monthly lease payment. Some—like mileage allowance, purchasing options after the lease term ends and depreciation of the vehicle—are widely known, while others are not.

The following are those you should know that might fall in the latter category:

  • Acquisition/termination fee. Also known as the bank fee, this covers administration costs and is paid either at the beginning of the lease (acquisition) or at the end (termination), according to Youngs.
  • Capitalized cost. This is the negotiated total cost of the vehicle. “When leasing a model that is in high demand and low supply, the capitalized cost may be the Manufacturer’s Suggested Retail Price (MSRP) or higher,” Youngs said in an April 2013 article from J.D. Power and Associates.
  • Capitalized reduction payment. Also known as the cap-reduction payment, this is the down payment made on a lease term to help reduce the monthly payment amounts. It is nonrefundable, Youngs said.
  • Destination charge. This is the nonrefundable cost for the vehicle to be delivered to the dealership.
  • Drive-off fee. This is the total amount due at signing. Just as when purchasing a car, there will be title fees, registration fees and sales tax to account for, though leased vehicles incur sales tax on monthly payments only, said Tony Quiroga, Car and Driver magazine senior editor, in a February 2015 article.
  • Money factor. Also known as the finance factor or finance charge, this number is used to calculate your interest rate by multiplying the money factor by 2,400, Young said. For example, a money factor of .00350 would be an 8.4 percent interest rate.
  • Rent charge. “This is the amount of the lease payment that comes from interest charges,” Quiroga explained. “To calculate the rent charge, add the adjusted cap cost to the depreciation and multiply by the finance factor,” and then multiply by the total number of months in the lease term.  
  • Residual value. According to Youngs, this is the “predicted value of the vehicle at the end of the lease.” Quiroga pointed out that with residual value, “the less it’s worth, the higher the lease payments.”
  • Subsidized lease. “Many advertised lease deals are subsidized leases, meaning that the auto manufacturer determines, in advance, the financial variables used to calculate the lease payment and takes on a certain degree of risk in order to create an attractive or class-competitive payment,” Youngs warned. He added that subsidized lease terms are nonnegotiable and often require a cap-reduction payment.

Additional lease information

There are a few other details to note in regard to leasing, depending on the vehicle you choose and any additional services you purchase.

Gap insurance is often included in lease terms as an additional fee. According to Youngs, this automotive insurance helps meet the gap between your insurer’s paid amount and the total residual value due to the leasing company in the even that your vehicle is stolen or damaged beyond repair.

A service contract is also offered as part of a lease contract, in which the consumer agrees to pay a discounted price up front to the dealership to have the vehicle serviced by the dealership for all of its future repair and maintenance needs.

“Before buying a service contract, make sure the brand of vehicle selected does not offer free scheduled maintenance for a limited time,” Youngs said.

Finally, it’s important to note that your base monthly payment is not the total amount you have to pay each month within a lease. The base monthly payment is simply the depreciation value plus the rent charged, divided by the number of months in the lease term. Your total monthly payment—what you actually pay each month—is the base payment plus tax.

 

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