Lease Definitions

Car leasing is the leasing of the use of a motor vehicle for a fixed or indefinite period of time.

  • It is commonly offered by dealers as an alternative to vehicle purchase.
  • The key difference in a lease is that after the lease expires, the lessee must return the vehicle to the dealer or buy it.
  • Leasing offers advantages to both buyers and sellers.
  • For the buyer, lease payments will usually be lower than payments on a car loan would be, and qualification is usually easier.
  • Some consumers may prefer leasing as it allows them to simply return a car and select a new model when the lease expires, allowing a consumer to drive a new vehicle every few years without the responsibility of selling the old vehicles.
  • A lessee does not have to worry about the future value of the vehicle, while a vehicle owner does.
  • For the lesser, leasing generates income from a vehicle the lesser still owns and will be able to lease again or sell through vehicle re marketing once the original lease has expired.
  • As consumers will typically use a leased vehicle for a shorter period of time than one they buy outright, leasing may generate repeat customers more quickly, which may fit into various aspects of a dealer’s business model.  (Wikipedia for Vehicle Leasing)

A Simple Description of Lease

*Note – This is not an accurate definition of lease contract and terms. This is just a brief description to make the concept more understandable.

  • A lease contract is similar to renting a car in some aspects, and is similar to buying a car in some other aspects.
  • By signing this contract customers can start operating a vehicle (Inventory item) for a specific time.
  • They can pay some of the fees and liabilities through total down payment (cash down payment, deferred payments, trading in a vehicle, and the rebates offered by manufacturer).
  • In the end of the contract the customer has to give the vehicle back to dealership; however, if the contract offers a purchase option, customer can negotiate buying the vehicle.

Description of Terms and Formulas

  • The key difference between buying the vehicle and leasing is that the customer does not own the vehicle when he leases it.
    • He is paying a fixed lease charge (rent charge) on each period in order to operate the vehicle (Lease charge portion of periodical payment).
    • However, since value of the vehicle would depreciate during the life of contract, the dealership also charges the customer for total depreciation of the vehicle in life of the contract (Scheduled Depreciation amount); this amount will be collected through periodical payments (Depreciation portion of periodical payment).
  • “Lease charge portion of periodical payment” combined with “Depreciation portion of periodical payment”, forms “Base periodical payment”.
    • Tax is applied on base periodical payment and total value of lease charge portion, depreciation portion, and tax forms scheduled periodical payment which customer should pay on each period.
  • When dealership calculates the lease they can decide what kind of fees they want to collect up-front (through total down payment) or they want to add them up and collect them through periodical payments.
    • A fee is Capitalized if it is going to be collected through periodical payments, and is non-Capitalized if it is going to be collected up-front.
    • Sometimes capitalized is just called cap.
  • Higher capitalized fees (lower non capitalized fees) comes to higher periodical payment and in contract.
    • Lower capitalized fees (higher non capitalized fees) comes to lower periodical payment, but requires higher down payment.
  • Total amount of capitalized fees are called gross capitalized cost, and total amount of non-capitalized fees are called total non-capitalized cost.
  • When signing the lease contract, the dealership will use total down payment to pay all of the taxes, to collect the total non-capitalized cost, to collect the security deposit, and to collect the first periodical payment.
    • The remaining amount after reducing all of these fees from total down payment will be called capitalized cost reduction.
    • Gross total capitalized will be reduced by capitalized cost reduction to get the adjusted capitalized cost.
  • Scheduled depreciation of a vehicle is the amount the vehicle declines in value over the term of the lease.
    • It may be calculated by subtracting the residual value (the amount the car is worth at the end of the lease) from the adjusted capitalized cost.
  • Base residual value is calculated in three ways:
    1. Applying a residual rate% to manufacturer suggested retail price (MSRP) of the car.
    2. Applying a residual rate% to Published residual value of the car.
    3. Putting the residual value manually into the program.
  • Residual value of the car is calculated by adding a Mileage schedule adjustment amount to take the extra/less mileage of the car into consideration.
    • Mileage schedule adjustment amount is calculated automatically by applying a positive or negative rate called as Mileage schedule adjustment rate%.
  • Total lease charge is calculated by using a number called Contract Rate or Money factor; a leasing term that expresses the cost of borrowing.
    • It is similar to the interest rate paid on a conventional car loan, but it is expressed as a difficult-to-understand fraction.
    • To convert an APR to Contract Rate just divide it by 2400.
    • Contract Rate is multiplied by the addition of adjusted capitalized cost and residual value of the car to come up with total lease charge.
    • Please notice that the customer is currently using both future value of the car and adjusted capitalized cost, so rent charge should be applied on both.

To get more useful information you can visit the Federal Reserve’s website.