Car Leasing Terms Explained in Plain English

Car leasing is very similar to renting. It makes "owning" a new car more affordable (at least in the short-term).

Contrary to what most people think, car dealers are not the ones who offer leases. Leases are actually done through leasing companies, banks, or the finance division of a car manufacturer (such as GM Financial or Ford Motor Credit).

When you lease a car, the dealer sells the vehicle to the leasing company at the price you negotiate (read our negotiating guide). The leasing company then turns around and leases the car to you based on that purchase price.

This is why it's so important to negotiate the selling price of the car first before leasing. Car dealers love the confusing nature of a lease because it's easy for them to pad on extra profits without you ever realizing it.

Leasing Terms Explained in Plain English

In order to understand leasing, you need to understand the following terms used to calculate your monthly payments. (don't worry, it's simple once you understand).

Capitalized Cost

This is the most important part of a lease, sometimes referred to as "cap cost". It's the negotiated selling price of the car plus any additional fees you might want to include in the monthly lease payment (such as acquisition fee). The lower you negotiate the purchase price of the car, the lower your monthly payment will be.

Most dealers will try to charge MSRP (Manufacturer's Suggested Retail Price). Don't fall for that - negotiate just like you would if you were buying the car outright.

Capitalized Cost Reduction

"cap reduction", this is basically anything that lowers the cap cost - such as a down payment, trade-in allowance, or rebates. Assuming you negotiated the purchase price at $35,000 and you put $3,000 as a down payment, your capitalized cost is now $32,000 and your capitalized cost reduction is $3,000.

Adjusted Capitalized Cost

Sometimes referred to as "net capitalized cost", it's the cap cost minus the cap reduction. This is the figure the leasing company will use to determine your monthly payments.

Acquisition Fee

This is the fee leasing companies charge to arrange the lease and is usually just a straight profit for them. Not all leasing companies charge this fee, but when they do, it's usually between $500 and $1,000 - and it's not negotiable. The acquisition fee can be bundled into the monthly lease payment by adding it to the Capitalized Cost.

Depreciation

You've probably heard the saying that the value of a new car drops 15% as soon as you drive it off the lot. This statement refers to depreciation.

Typically, the price of a new car drops 50% after 3 years. Remember that the leasing company actually owns the car and is "renting" it out to you.

The problem is, when you return the car, it's going to be worth a whole lot less than when you first started leasing it and you're going to have to pay for this loss in value.

Therefore, depreciation makes up the largest part of your lease payment so you need to pay close attention to this. Some cars depreciate more than others. Cars like BMW and Mercedes retain their value well, which explains why many of their sales go to leasing. (See: Best Cars to Lease if You Want a Great Deal)

Residual

This is the amount your car is worth at the end of the lease. Depreciation and Residual go hand in hand - if you know one, you can calculate the other.

Let's say you purchased a car for $40,000. After 4 years, the depreciation on the car is $25,000 - therefore, the residual is $15,000.

The residual value is calculated before you sign the lease. Most leasing companies use the Automotive Leasing Guide (ALG), an industry guidebook that calculates the predicted values of new cars after they come off lease.

Money Factor

This is what confuses most people when it comes to leases. Money factor is actually pretty simple, it just refers to the interest rate but is calculated differently. (Again, car dealers love the confusion since it allows them to add in hidden profits)

The money factor is represented as a number such as ".0029". To convert this to a more familiar interest rate, you simply multiply by 2,400. A money factor of .0029 equals roughly 7% interest.

Here's a table showing you what each money factor converts to:

Money Factor	Interest Rate	Money Factor	Interest Rate	Money Factor	Interest Rate
0.0005	1.20%	0.0037	8.88%	0.0069	16.56%
0.0006	1.44%	0.0038	9.12%	0.0070	16.80%
0.0007	1.68%	0.0039	9.36%	0.0071	17.04%
0.0008	1.92%	0.0040	9.60%	0.0072	17.28%
0.0009	2.16%	0.0041	9.84%	0.0073	17.52%
0.0010	2.40%	0.0042	10.08%	0.0074	17.76%
0.0011	2.64%	0.0043	10.32%	0.0075	18.00%
0.0012	2.88%	0.0044	10.56%	0.0076	18.24%
0.0013	3.12%	0.0045	10.80%	0.0077	18.48%
0.0014	3.36%	0.0046	11.04%	0.0078	18.72%
0.0015	3.60%	0.0047	11.28%	0.0079	18.96%
0.0016	3.84%	0.0048	11.52%	0.0080	19.20%
0.0017	4.08%	0.0049	11.76%	0.0081	19.44%
0.0018	4.32%	0.0050	12.00%	0.0082	19.68%
0.0019	4.56%	0.0051	12.24%	0.0083	19.92%
0.0020	4.80%	0.0052	12.48%	0.0084	20.16%
0.0021	5.04%	0.0053	12.72%	0.0085	20.40%
0.0022	5.28%	0.0054	12.96%	0.0086	20.64%
0.0023	5.52%	0.0055	13.20%	0.0087	20.88%
0.0024	5.76%	0.0056	13.44%	0.0088	21.12%
0.0025	6.00%	0.0057	13.68%	0.0089	21.36%
0.0026	6.24%	0.0058	13.92%	0.0090	21.60%
0.0027	6.48%	0.0059	14.16%	0.0091	21.84%
0.0028	6.72%	0.0060	14.40%	0.0092	22.08%
0.0029	6.96%	0.0061	14.64%	0.0093	22.32%
0.0030	7.20%	0.0062	14.88%	0.0094	22.56%
0.0031	7.44%	0.0063	15.12%	0.0095	22.80%
0.0032	7.68%	0.0064	15.36%	0.0096	23.04%
0.0033	7.92%	0.0065	15.60%	0.0097	23.28%
0.0034	8.16%	0.0066	15.84%	0.0098	23.52%
0.0035	8.40%	0.0067	16.08%	0.0099	23.76%
0.0036	8.64%	0.0068	16.32%	0.0100	24.00%

Term

The term of the lease is how long you will be leasing the car for. Most leases have 24, 36, 48 and 60 month terms. the longer your term, the lower your monthly payments, however, you'll end up paying more in interest.

Lessee

This is the person who will be leasing the car - you!

Lessor

This is the leasing company. They are the ones who legally own the vehicle. This can be a bank, an independent leasing company, or the finance division of a car manufacturer.

Gap Insurance

Gap insurance protects you in case the car is stolen or totaled. Most leases come with gap insurance for no additional charge, but if it doesn't, make sure to get it. (See: Why You Need to Have GAP Insurance When Leasing a Car)

Security Deposit

Not all leases require a security deposit. This is very similar to when you rent a house and the landlord requires a security deposit in case you damage the residence. A security deposit with a lease ensures that you will pay any damages you cause to the vehicle when you turn it in.

Disposition Charge

Leasing companies claim this charge is to cover their expenses when it comes to cleaning and selling the car after you turn it in at lease-end, but it's usually another profit center for them. Most charge around $250.