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In order to get the lowest lease price possible, you must learn how to calculate a lease. Here's a long and in-depth guide to how leasing works, plus real world examples from my most recent lease.
I have seen a lot of posts recently about best practices with car buying, but I haven't seen anything on how to lease a car. So I figured I'd write this up!
Ok, let's get this out of the way right away: Leasing isn't for everyone. In fact, it's probably a bad idea for most people. But if you are going to lease, you need to know how leases work and where they get the numbers in order to get the best deal. And knowing the numbers may actually make you realize it's a terrible deal and to stay away.
But for this post, I'm not debating the merits of leasing, just explaining HOW the math works, what your costs actually are and how to realistically minimize those costs.
This post will include the following info:
The math behind the calculation
What kind of car to look for
Where to find the info you need
How to negotiate the best lease
The Math
Let's start with how the lease monthly payment is calculated.
The formula is: Payment = Depreciation + Finance charge.
Your depreciation is: ((Capitalized Cost - Residual Value) / Number of Months)
Your Finance charge is: ((Capitalized Cost + Residual Value) * Money Factor
So your total formula is: Payment = ((Capitalized Cost - Residual Value) / Number of Months) + ((Capitalized Cost + Residual Value) * Money Factor)
Pretty simple right? So what do those things mean?
Capitalized cost: This is the amount financed. Did you know in a lease, you are actually financing the depreciation? This can be higher or lower than the price of the car, depending on whether or not you are putting money down, rolling over negative equity, or tacking on fees into your payment. The lower the better!
Residual value: This is what the manufacturer (or the bank, if using a separate lease provider) thinks the car will be worth at the end. It's expressed as a percentage. 50% or 0.50 means they think it will be worth half as much in the end. The more miles you want, the lower the residual will be. Residual can also vary by trim package (i.e., the "Limited" has a higher residual than the "Sport"). The higher the better!
Money factor: This is the interest rate. For some reason, it's always actual interest rate / 2400. So 4% = 0.0016 and 0.9% = 0.000375. The lower (more zeroes) the better!
Number of months: How long you want to lease for. Sometimes manufacturers juice the leases depending on months. For example, VW wanted to move Jetta GLIs off their lots a few years ago, and had insanely inflated residuals and ridiculously low money factors on 2 year leases, making them about $100/mo less than a 3 year lease.
Refundable security deposits: This is expert level leasing. Almost no one knows about it, even dealerships. But some banks allow you to put down a refundable security deposit in order to lower your money factor. This is usually for people with low credit to secure the rates of someone with higher credit, but some let people with top tier credit put down money to get an even lower rate. I was told by the finance manager and the sales manager at one Toyota dealership that I was wrong. I asked them to call Toyota, and they came back and said "well, you learn something new everyday". If you are doing a refundable security deposit, simply calculate if the reduced payment on your lease will be higher than the guaranteed return on your money. In other words, if you put down $3000 and get $20/mo off, at the end of 3 years you'll have $3000+20x36 = $3,720. That's a 7.44% guaranteed return!
Type of car to look for
To get the cheapest lease possible, you want to find a car that the manufacturer is discounting (this will reduce your 'cap cost'), which has a naturally high resale value (think Honda or Toyota), and a low money factor (triple zero!).
You can monitor for specials, search online for deals, or call around when you are looking for a car. If manufacturers are advertising cheap lease deals, it probably means they are either discounting the car or offering a really cheap money factor. Just realize that if it's being advertised, you can do better by negotiating.
As with anything, google is your friend as well: I got my parents a great lease deal by googling "current lease deals" and finding out that Mazda was basically doing interest free leases - they're driving a $30k car for $315 a month, with zero money out of pocket.
Where to get the info
So now you know you want to lease a car. You need to start filling in the blanks. What are the sources of this information:
Dealerships. They won't tell you easily, but if you make it clear you are a serious buyer, they'll share the real info with you. I've found that sales managers and internet departments are the most likely ones to share the info.
Edmunds TMV. This a great source to find out how much cars are actually selling for in your area. You can option the car and price it out and see if it's realistic to get a car below invoice or at msrp or somewhere in between.
CarGurus. I've found this site/app super helpful for knowing what specific cars are available in an area, what the average price is, and how long the car has sat for.
Edmunds vehicle specific forums. This is the best source I've found for up to date residuals and money factors. The mods of the forums answer specific questions on current vehicle offers.
Google. If you google "money factor + residual + [make/model]" you might find another source that will break it down for you.
I like to find all of the numbers, plug them in, figure out what the monthly payment would be, and then start calling dealerships to confirm my numbers are right. This makes negotiation easy - figure out what you want to pay, figure out a reasonable price, and then find someone who will sell it to you for that. Speaking of...
The negotiation
Here's where it can get tricky. Even if you know the numbers and know what you're trying to do, they'll still try and add stuff on. There are curveballs everywhere.
Also, it's going to be rare that you'll find a sales person who will dive into calculating at this level. They will ask you about monthly payment, your trade-in, what you want to pay. You need to be firm and stick to your plan. The last time I leased this led to me walking out of one dealership after they wouldn't play ball. Their loss, I walked into one the next weekend and leased the same car for LESS than I was willing to pay at the first one.
The key strategy is this: focus on the sale price of the car. You already know the money factor and residual. Those are driven by the bank and the dealer can't budge (unless they find you another bank). You want to negotiate the lowest sale price possible. This is where the Edmunds TMV and Cargurus info is so helpful.
Do not talk about down payments. Do not talk about monthly payments. Do not talk about trade-ins. Do not talk about anything except the sale price of the car.
Why is this so important? Because the residual is always calculated based on the MSRP of the car. But the closer the residual is to the sales price, the less depreciation you are financing. So the lower "sale price" you can base the lease on, the cheaper your payment!
Some other tips to think about when negotiating:
Never put money down. All a downpayment does is reduce your cap cost. But if you drive off the lot that day and get slammed by an 18 wheeler and have the car totaled, you'll never see that money again. NEVER PUT MONEY DOWN.
If you can, sell your car privately. Don't trade it in on a lease. Why? See above. It's money, and it may disappear. There are obviously exceptions to everything, but in general, don't trade a car in.
Watch for additional fees. Dealers charge for document fees ($100-$500, may or may not be negotiable) and a host of other factors. Ask for these to be separated out, then decide if you want to lease them. When your money factor is near 0, you may be ok with "financing" these costs. But you may just also want to pay them up front (note: this isn't a down payment).
Taxes: these vary by state, but in my state they're based on a prorated lease rate. So it's a monthly payment of (6.5% x calculated monthly payment) is added on to your total payment.
So what are some real world examples:
I currently lease a 2017 Toyota 4Runner Off Road Premium. The MSRP of my car is $40,500. Toyota was running a lease special of $399/mo with $2,999 down, plus taxes and fees for a base SR5 that goes for about $37k. Seems like a great deal, right? And I should be paying more for a more expensive vehicle than their current special, right?
Well, I looked up on edmunds and found out that the car was actually selling for closer to $38k. Cargurus confirmed this, and also showed that several were available near me and had been sitting on lots for a couple weeks. I did some research and found out the residual was high for a 3 year, 36k mile lease (I think 65%) but the money factor was kind of meh (0.00225). Let's see the differences, using the MSRP:
Payment = ((Capitalized Cost - Residual Value) / Number of Months) + ((Capitalized Cost + Residual Value) * Money Factor)
((40,500 - (40,500 x .65))/36 = ($40,500-$26,325)/36 = $393.75 +
((40,500+ (40,500 x .65)) x .00225) = $150 = $544/mo .
Ok, now let's play around with this a little bit. Let's remove $3000 from the "capitalized cost" after we learn that the average Edmunds selling price is $2500 below MSRP (and we're going to negotiate a little better than average).
((37,500 - (40,500 x .65))/36 = $310 + ((37,500+(40,500 x .65)) x .00225) = $143 = $454/mo
We just dropped almost $90 off the price by knowing what we can actually get the car priced out. How do we lower the price a little more? Turns out, Toyota will drop the MF from 0.00225 to 0.00153 if you put down $3600 in fully refundable security deposits, returned in full at the end of lease completion. Let's run the math again.
((37,500 - (40,500 x .65))/36 = $310 + ((37,500+(40,500*.65)) x .00153) = $98 = $408/mo
Another $50 off. We dropped our interest rate from 5.4 to 3.67 and the price came down accordingly.
Now, let's plug the same numbers in and push for a … [more]
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