You’re looking to lease a car and you stop by your local dealership to test drive the one you want, but then it comes to the negotiation part and you’re a bit lost. Most likely the salesperson will present to you a paper with four boxes in it with numbers that don’t exactly make much sense, but he tells you that he can put you in the car for $x per month.
You look at this paper and the numbers aren’t really connected in any way and you’re not sure what you’re negotiating, except maybe the final monthly lease price.
You really only need to ask the salesperson for three things:
- Sale price
- Money factor
- Residual value
I recently helped a friend out with a lease negotiation and it got frustrating because every time I asked the salesperson for those three things, he would disappear for 10 minutes and come back with a lower monthly payment amount. I would then remind him that he said he would go and get the numbers I asked for, and so he would go back and leave us sitting there for 10 minutes and come back with another price.
Finally it took some getting agitated before he came back with the numbers I asked for.
Here’s what those numbers mean:
- Sale price: This is the “purchase” price of the vehicle. This is extremely important because it will probably be the most negotiable number. You looked at the manufacturer’s suggested retail price (MSRP) in the car’s window, right? Chances are they are trying to lease the car to you at this price, which no one ever pays (unless you’re not asking for this number).
- Money factor: This is essentially the interest rate you’re paying. Normally the car manufacturer owns its own financing company, which is actually the entity that is purchasing the car from the dealer when you lease. You then lease the car from the financing company. The money factor is the amount the financing company is charging you to essentially borrow the money to purchase the car, which they then lease to you. The money factor is probably semi-negotiable, and this is where the dealer likely gets most of their kickbacks. Just asking for the money factor in the example above is all it took for the dealer to reduce the money factor during my negotiation. The money factor is usually presented as a very small decimal, such as .00350.
- Residual value: This number is important, but probably not negotiable. This is basically the value of the car that the financing company is guaranteeing at the end of the lease. For example, if you’re leasing a car that costs $25,000, and the residual value at the end of three years is $15,000, you are basically paying the difference in the value for your lease, so in this example $10,000 (plus the money factor).
Now that you’ve insisted on these thee numbers from the salesperson, you can figure out how much you’re paying for the lease (and also understand if they’re trying to take advantage of you).
First, the sale price of the car. For example, you found a car that shows an MSRP of $25,000 in the window. Of course you shouldn’t pay this amount. In my experience, it’s not too hard to get a final sales price of 10% (or more) below that number. So in this example, we negotiate a price of $22,500.
You’ve also got the residual value, which is set by the financing company. In our example, let’s say the residual value is $15,000.
A lease means that you’re paying for the difference between the sale price and the residual value, because the residual value is how much the car is worth at the end of the lease. In this case, you’re paying $7,500 over three years (or however long the lease is). $7,500 divided by 36 months is about $208 per month to lease this car. (As a side note, it’s usually a bad idea to get a lease longer than 36 months).
But wait, this is where the money factor comes into play. What does that weird small decimal mean? For example, .00350. How do you put that into an easier-to-understand form? Multiply it by 2400. Therefore, a money factor of .00350 is the equivalent of an 8.4% interest rate. Wow, that’s high! Particularly with car purchase deals these days of 0%. This is why you need to understand the money factor and push back when it’s too high.
In the example above, when I was helping my friend with a car lease, the initial money factor we were quoted was .00275. That sounds low, right? Well that works out to an interest rate of 6.6%. That still high. Just by questioning that number we were able to get the dealership to reduce it to .001375, or the equivalent of 3.3%.
Now we’re talking. How does this relate to the lease monthly payment? Keep in mind that you’re going to apply the interest rate to the entire value of the vehicle, not just the amount you’re paying to lease it.
For a rough way of figuring the interest portion of your lease payment, do the following:
- Take the difference between the purchase price and the residual value (in this case, $7,500) and divide it by two ($7,500 / 2 = $3,750). Now take $3,750 and multiply it by your interest rate. In our original offer from the dealer, that was 6.6%. Therefore, 3750 x .066 = $247.50. That’s one year of interest, so we divide that by 12. 247.50 / 12 = 20.63. Therefore, we add that to our monthly lease payment above: $208 + 20.63 = $228.63.
- We’re not done. Now you need to figure the interest portion of the residual value. This one is easier. Just take the residual value, multiply that by the interest rate, and then divide that by 12. In our original example: 15,000 (residual value) x .066 (6.6% interest rate) / 12 = 82.50. So we add that to our payment above: 228.63 + 82.50 = $311.13.
That’s our lease payment! $311.13.
But what if we negotiate down the money factor? Let’s try the money factor that I was recently able to get for my friend:
- 7,500 / 2 x .033 / 12 = $10.31
- 15,000 x .033 / 12 = $41.25
- Add those to our base lease payment: 208 + 10.31 + 41.25 = $259.56
Just by negotiating down our money factor we reduced our payment by $51.57. You can see how much of a difference that makes.
So, next time you want to lease a car, insist on knowing the sale price, money factor, and residual value. You now know how to do the math and understand exactly what the dealership is selling you. Good luck with your next car lease!