Smart Buying Essentials

Leasing Glossary

Unfortunately, the details of leasing make new-vehicle shopping all the more complex. And the savvy lessee must learn a new vocabulary.

Acquisition Fee. An acquisition fee is a charge for processing a lease and is probably not negotiable. On a shorter term lease, the acquisition fee can have a large impact on the cost of the lease.

Base Interest Rate. This represents the interest paid on the usage of the vehicle during a lease. It is the ‘cost’ of a lease before factoring in discounts, fees, and penalties and is not directly comparable to the APR for a loan.

Lowering the base interest rate is one of the methods manufacturers use to subsidize leases. The phrase ‘money factor’ measures the same cost and can be converted into a base interest rate. For example, to convert a money factor of 0.00276 into an approximate base interest rate we would multiply the money factor by 24. The result would be 0.0662 or 6.62%.

Buy at end-of-term interest rate. This is the effective net interest rate for the lease if, at the end of the lease, the car is purchased at the end-of-lease purchase price.

Capitalized (Cap) Cost. This is the total price of the vehicle, in effect, its purchase price. In theory, the cap cost should equal the amount you would pay for the vehicle if you were purchasing the vehicle. When a lease is made, the dealer sells that vehicle to the leasing company (for the cap cost), which then leases the vehicle to you.

Capitalized (Cap) Cost Reduction. This is a fancy name for a cash down payment, money you pay up front that is applied to the final purchase price. A large cap cost reduction will, of course, reduce the monthly payments, but it will also negate one of the big advantages of leasing. However, if you own your present car, you may be able to use it, as a trade-in, to satisfy the cap cost reduction to start the lease. Remember, you must pay sales tax on any cap cost reduction you make. Another source of capital cost reduction may be dealer or manufacturer participation. Dealers and manufacturers will sometimes lower the cap cost or offer a rebate that reduces the cap cost. A dealer or manufacturer cap cost reduction does lower your total out-of-pocket dollars, unlike a cap cost reduction that you must pay.

Closed and Open End Leases. Most leases offered today are closed-end leases, meaning that the residual value is fixed and stated in the lease contract. The lessee’s financial obligations are unaffected by what the vehicle is actually worth when the lease ends. In other words, the lessee assumes no risk for the depreciation of the vehicle.

With an open-end lease, there is still a residual value set at the beginning of the lease. However, if the car is worth less than the residual value at the lease’s end, the lessee must pay the difference. In other words, the lessee assumes the risk for depreciation with an open-end lease.

Dealer Participation. This is the amount contributed by the dealer to reduce the final purchase price in the lease contract. Dealer participation can take the form of a rebate or simply a discount. The dealer participation is reflected in the lease contract as a capitalized cost reduction.

Depreciation. The amount by which property loses its value. In automobile leasing, depreciation is the difference between the new car cost and the value of the car at the end of the lease.

Disposition Fee. This is a fee you pay at the end of the lease, to the lessor, that covers the lessor’s cost of getting the vehicle ready for sale after you have returned the vehicle. It is often applied against any deposit you made at lease inception.

Down Payment. See capital cost reduction.

Early Termination. A vehicle’s depreciation is highest in the first few months after it leaves the dealer’s lot. Since a lessee pays for depreciation in equal monthly payments, lessees who end a lease early have almost always used up more of a car’s value than they’ve paid for. Therefore, lease contracts generally include penalties for early termination. Be aware of these penalties before you sign the lease contract and consider your ability to fulfill the contract.

End-of-Lease Purchase Price. If there is a purchase option in the lease contract or agreement, this will be the agreed upon price for the purchase of the vehicle at the end of the lease-the stated residual value. This price may also include additional fees.

Final Purchase Price. This price is equivalent to the amount you would pay for the vehicle if you were buying or financing rather than leasing. The final purchase price does not include any ‘down’ payment by the lessee.

Gap Insurance. This protects you against additional losses not covered by your auto insurance in the case of an accident in which the vehicle is totaled. Most auto insurance will cover the actual cash value of the car at the time of its loss. Gap insurance covers the difference (gap) between the actual cash value of the vehicle and what is owed on the lease contract, including early termination fees. Gap insurance is most important in the early years of a lease when the difference between the value of the car and what is owed are greatest. Some manufacturers now include Gap insurance in their leases.

Lease Term. This is the duration of the lease. The most common lease durations are 24 and 36 months, though 12, 48, and even 60-month leases are available. Remember that your monthly payment will change depending on the length of the lease.

Lessee. The individual or party signing the lease contract and taking responsibility for the vehicle and lease payments.

Lessor. The individual, dealer, business, manufacturer, or financial institution that owns the vehicle.

Independent Lessor. Independent Lessors are usually individual businesses that can provide for the lease of virtually any make or model of vehicle. Independent lessors, like dealers, can write custom leases, including those with different conditions and special mileage considerations.

MSRP. Manufacturer suggested retail price.

Manufacturer Discounts. In some leases, particularly subvented leases, the manufacturer reduces the MSRP to lower the purchase price of the vehicle, which the lease is based on. This is a form of capitalized cost reduction.

Mileage Allowance. Mileage Allowance. Lease agreements usually establish the average miles per year that the car may be driven, typically this is often between 12,000 and 15,000 miles. The lease contract also establishes the amount you’ll have to pay for every mile driven over the allowance. This mileage fee is usually 15¢ per mile. You can often purchase additional miles at the start of the lease at a discounted rate. If you’re sure you’re going to drive more than the number of miles allowed, then your best option is to negotiate for a higher allowance on the lease.

Money Factor. The most common way to express the base interest rate of a lease is as a money factor. If you multiply a money factor by 2400, the result will be equivalent to the base interest rate. The money factor of most leases is known by a dealer’s sales staff. The money factor measures the cost of money, just like an interest rate. However, money factors are used almost exclusively in leases, whereas interest rates are used everywhere else.

Monthly Payment. The amount that must be paid each month to satisfy the lease contract. It is common for the monthly payment shown in lease advertisements to exclude applicable taxes, which will add to the amount paid each month.

Net Capitalized Cost. This is the price of the vehicle after deducting any dealer participation, manufacturer discounts, and cap cost reduction (‘down’ payment) from the MSRP.

Net Interest Rate. This is the total interest rate for the lease. It represents the lease's true cost, similar to an APR for a bank or credit union loan. The lower the net interest rate, the lower the cost of the lease.

Opportunity Cost. The cost of what you didn’t do. For instance, if you have the cash to buy a car, the opportunity cost of the purchase is the interest lost on the cash you used for the car. One of the often-cited advantages of leasing is that it frees up your money to invest elsewhere.

Purchase Option. Most closed-end leases grant the lessee an option to purchase the vehicle at the end of the lease. The end-of-lease purchase price is usually the same as the stated residual value. Check your lease contract before signing to ensure that there is a purchase option. The lessor must disclose the purchase option price prior to your signing the lease contract.

Purchase Price. This is the price you would expect to pay for the vehicle if you were financing or buying the vehicle. To determine the purchase price, start with the MSRP and subtract any manufacturer discount and dealer discount you negotiate. Purchase price is a key determinant of the true cost of a lease. Purchase price less your down payment and dealer participation equals the net capitalized cost.

Refundable Deposit. This is a refundable deposit required at lease inception. In some cases it may be used to satisfy the final monthly payment. It is sometimes called a security deposit.

Residual Discount. If the end-of-lease purchase price (stated residual value) is greater than the expected end-of-lease value (expected residual value), the dollar difference represents the value of the vehicle that you will not pay for during the lease.

Residual Penalty. If the end-of-lease purchase price (stated residual value) is less than the expected end-of-lease value (expected residual value), the dollar difference represents the additional value of the vehicle you’ll pay for during the lease.

Residual Value, Expected. This is the projected value of the vehicle at the end of the lease. Residual value is a measure of the vehicle’s expected depreciation.

Residual Value, Stated. The stated residual value is usually the same as the end-of-lease purchase price. The higher the stated residual value of the car, the lower your monthly payments. Stated residual values are often higher or lower than the expected residual value. By adjusting the stated residual value for a car, the lessor can raise or lower the monthly payments and the net interest rate for the lease. Stated residual value also determines whether you should buy the vehicle at the end of the lease. If at the end of a lease, the vehicle’s market value is less than the stated residual value, the lessee would be prudent to not purchase the car. On the other hand, if the actual market value were greater than the predetermined residual, then the lessee could buy the car, sell it, and pocket the difference.

Subvented (Subsidized) Lease. A subvented lease is a lease offered by manufacturers with special incentives to make it more attractive. These incentives often take the form of a lower base interest rate, higher residual values, and manufacturer discounts. In many cases, a subvented lease will have a lower net interest rate than other leases. Subvented leases are usually only available for a limited time and the terms are not negotiable. Any negotiated change in the terms will result in a different net interest rate.

Total Out-of-Pocket Cost. This is the total of all monthly payments, any lease fees and deposits, and any capital cost reduction (except tax, license, and registration) from lease inception to closure.

Wear and Tear. It’s your responsibility to keep the car in good condition. Return the car with a dented fender, bald tires, or a ruined engine because of lack of routine maintenance and you’ll be charged for the repairs. Some wear and tear is allowed, of course. But if you aren’t inclined to take reasonable care of your car, leasing may not be for you.