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How car lease payments are calculated

Auto leasing comes with its own jargon that can be difficult to understand. If you’re ready to dive into the weeds and get all the details on how vehicle lease payments are calculated, this is the right page for you.

This explanation works for states where tax is levied on the monthly payment. The calculations will be different for states where the tax is due up front or on the total selling price of the vehicle.

Key leasing financial terms

In order to calculate lease payments, you’ll need to have the following information:

  • MSRP: The Manufacturer’s Suggested Retail Price. This is the price set by the manufacturer (i.e. Honda).
  • Selling Price: This is the price of the vehicle as offered by the dealership. If there are any manufacturer incentives and discounts, these are taken into account in the selling price.
  • Capitalized Cost: The amount being financed; in other words, the total of all your monthly lease payments. Any “down payment” you make will reduce the capitalized cost.
  • Residual Value: This is what the bank or leasing company estimates your vehicle to be worth after the lease expires. This value is typically expressed as a % of MSPR.
  • Depreciation: For leasing, depreciation refers to the total amount you finance, minus the residual value.
  • Term Length: The length of the lease agreement in months. 36 months is common (3 years).
  • Money Factor: In leasing, the money factor is used to calculate the interest charged on the lease. The money factor can be converted to APR by multiplying by 2,400. For example, a money factor of 0.001 can be converted to an APR of 2.4% (0.001 * 2400).

Let’s get started!

Step 1: Monthly Depreciation

To calculate the estimated depreciation, first we need to know the residual value.

The residual is a value decided by the bank or leasing company. It’s just an prediction, and the vehicle’s actual value at the end of your lease will probably be either higher or lower than the residual. Banks estimate residual based on the vehicle you are leasing, the term length, and mileage. For example, a vehicle that’s driven 15,000 miles per year for 3 years (total 45,000 miles), will be worth less than the same vehicle if it’s driven only 10,000 miles per year (total 30,000 miles).

The depreciation is calculated based off of the residual provided by the leasing bank (Honda Financial Services, etc.) and the capitalized cost.

Monthly Depreciation = (Capitalized Cost – Residual Value) / Months

Our example:

Imagine that you want to lease a vehicle for 36 months and 12,000 miles per year and the vehicle has an MSRP of $20,000. The dealership is offering a selling price of $19,000 ($1,000 dealer discount) and the manufacturer is offering a $1,000 incentive. For your specific vehicle, 36-month term length, and mileage restrictions, the bank has set a residual percentage of 61%.

Based on the residual percentage, the bank estimates that your vehicle will be worth $12,200 ($20,000 × 0.61) at the end of your lease. This is your residual value. Note that we used the MSRP to calculate the residual value, not the selling price.

Capitalized cost is the amount being financed. This is typically the selling price minus incentives and down payment and plus fees. In this example, our capitalized cost is $18,000 ($19,000 selling price – $1,000 manufacturer incentive).

Depreciation is calculated by subtracting the residual value ($12,200) from the capitalized cost ($18,000). In this simplified example, the depreciation would be $5,800. To get our monthly depreciation, we divide our total depreciation ($5,800) by the term length in months (36).

Monthly Depreciation = ($18,000 – $12,200) / 36

Monthly Depreciation = $161.11

Step 2: Monthly Finance Charge

The formula to calculate the monthly finance charge is simple. Check it out below:

Monthly Finance Charge = (Capitalized Cost + Residual Value) × Money Factor

Our example:

Continuing with the same example in Step 1, we already know our capitalized cost and residual value. They are $18,000 and $12,200 respectively. The money factor is what indicates how much interest will be charged. It can be expressed as an APR by multiplying the money factor by 2400. For example, a money factor of 0.001 could be seen as a 2.4% APR. In this example, the bank has offered us a money factor of 0.001. Let’s plug this into our formula:

Monthly Finance Charge = ($18,000 + $12,200) × 0.001

Monthly Finance Charge = $30.20

Step 3: Base Monthly Payment

The base monthly payment is the payment expressed before tax has been added. To calculate your base monthly payment, simply add your monthly depreciation to your monthly finance charge. Here’s the basic formula:

Base Monthly Payment = Monthly Depreciation + Monthly Finance Charge

Our example:

Add the monthly depreciation ($161.11) to the monthly finance charge ($30.20) for a base monthly payment of $191.31. Note that this payment does not include tax or fees. A standard lease like the one we are calculating here charges the first payment and fees upfront at lease inception. Let’s plug our values into the formula below:

Base Monthly Payment = $161.11 + $30.20

Base Monthly Payment = $191.31

Step 4: Monthly Lease Payment

The last thing that we need to add into the payment is tax. Lease taxation varies greatly by state. For this example, we will use Minnesota. In Minnesota, tax is levied on the lease payment. This means that we need to calculate the tax for each lease payment and add it to the payment. Some other states tax on the full cost of the lease and require the tax upfront. Some states even tax on the full selling price of the vehicle, creating a huge tax bill and very expensive leases.

To calculate our monthly lease payment, we simply need to add the tax to our monthly payment using the following formula:

Monthly Lease Payment = Base Monthly Payment × (1 + Tax Rate)

Our example:

At the time of writing, the local tax rate is 7.125%. We will express this in our formula as 0.07125. Add 1 to the tax rate for 1.07125 and multiply that by the base monthly payment calculated in Step 3 for a monthly lease payment of $204.94:

Monthly Lease Payment = $191.31 × (1 + 0.07125)

Monthly Lease Payment = $204.94

This is the final monthly payment that you will be billed for. Good job!

Step 5: Drive-off and Disposition Costs

At lease inception, you should expect some upfront costs and maybe even a lease-end cost. These can include an acquisition fee, document fee, your first payment, registration fee, down payment, disposition fee, additional taxes and more. Let’s define these briefly:

  • Acquisition Fee: The acquisition fee is set by the bank offering the lease, and is almost never negotiable.
  • Document Fee: The document fee is a fee that covers the dealership’s processing of your – you guessed it – documents. This covers the dealership’s documentation processes that help to get your vehicle titled and registered with the state’s motor vehicle department.
  • Registration Fee: The registration fee is a state-imposed fee for registering your vehicle. This is essentially a tax and is non-taxable.
  • Down Payment: The down payment is an upfront cost that reduces the capitalized cost used to calculate your lease payment. The larger the down payment, the less your payments will be.
  • Disposition Fee: Depending on your lease agreement, a disposition fee may be charge at the end of your lease agreement.
  • Additional Upfront Taxes: Additional upfront taxes include taxes due on the acquisition fee, document fee, down payment, trade allowance, and other upfront, taxable charges.

Our example:

So now we know our monthly lease payment. It’s $204.94 per month. What else are we going to have to pay to lease this car? Let’s assume an acquisition fee of $595, a document fee of $100, and a registration fee of $400. We did not make a down payment in this example.

To calculate our drive-off (upfront costs), let’s first calculate the taxes we will owe on our fees and taxable cap cost reducers (down payment, taxable incentive, trade allowance). Let’s take the acquisition fee ($595), document fee ($100), down payment ($0), and manufacturer incentive ($1,000) and calculate our drive-off taxes due on those items:

Drive-off Taxes = (Acquisition Fee + Document Fee + Down Payment + Taxable Incentives + Trade Allowance) × Tax Rate

Drive-off Taxes = ($595 + $100 + $0 + $1,000 + $0) × 0.07125

Drive-off Taxes = $120.77

Next, we will add all of our drive-off costs and taxes for our total drive-off. Let’s sum up our first lease payment ($204.94), acquisition fee ($595), document fee ($100), registration fee ($400) and drive-off taxes ($120.77). If you are making a down payment, don’t forget to include that here. This leaves us with a total drive-off of $1,420.77. This is the amount due when you sign the lease.

Leasing Costs Summary

Lease costs can be typically be broken down into drive-off costs, lease payments, and disposition costs. Keep in mind that additional wear and tear on the vehicle could lead to more charges at the end of your lease.

Our example:

Let’s imagine the bank imposes a $395 disposition fee. The disposition fee is determined at the start of the lease. If we wanted to calculate our total lease cost, we would need to add our total drive-off, our total lease payments (don’t forget that one of these payments is in the drive-off), and our disposition fee. If you mistreat your vehicle, you may also incur wear and tear charges. Let’s assume you don’t. Here’s how that would look in a formula:

Total Lease Cost = Total Drive-off + (Monthly Lease Payment × (Term Length – 1))* + Disposition Fee

Total Lease Cost = $1,420.77 + ($204.94 × (36 Months – 1))* + $395.00

*We subtract 1 from the term length because the first payment is included in the total drive-off.

Total Lease Cost = $1,420.77 + $7,172.90 + $395.00

Total Lease Cost = $8,988.67

Additional Notes

The above formula is specifically used to calculate a lease where the first payment and fees are due at drive-off. It is also limited to states that levy tax on the lease payment, like Minnesota. Most states calculate lease taxes this way, however yours may be different.

In most cases, you may opt to roll your fees or taxes into your car lease payment to lower your drive-off. Note that the calculations become very different from the method listed here – especially regarding taxation.

Sign and Drive leases

You can even choose to roll all of your drive-off costs into your payment. This type of lease is referred to as a Sign and Drive lease. Sign and Drive leases are becoming increasingly popular as people prefer to trade upfront costs for an increased monthly payment.