How to Calculate Car Lease Payments — Money Factor, Residual & Depreciation

The Anatomy of a Car Lease

A lease is essentially a long-term rental where you pay for the vehicle’s depreciation during your term, plus interest and fees. Key components include:

• MSRP (Manufacturer’s Suggested Retail Price): The car’s list price.
• Capitalized Cost (Cap Cost): The negotiated purchase price—this is negotiable, just like buying.
• Residual Value: The car’s estimated worth at lease end, set by the finance company (e.g., BMW Financial, Honda Finance).
• Money Factor: A decimal representing the lease’s interest rate (e.g., 0.00125 ≈ 3% APR).
• Term: Typically 24–48 months.
• Mileage Allowance: Usually 8,000–12,000 miles/year; excess mileage incurs fees.

The Lease Payment Formula

Unlike loans, lease payments combine two separate fees:

1. Monthly Depreciation Fee
This covers the car’s lost value:
Depreciation = (Adjusted Cap Cost – Residual Value) ÷ Term

2. Monthly Finance Fee
This is the interest charge:
Finance Fee = (Adjusted Cap Cost + Residual Value) × Money Factor

Total Pre-Tax Payment = Depreciation + Finance Fee
Then add VAT (20% in the UK, applied to the total monthly payment).

Step-by-Step Calculation (UK Example)

Scenario:

• MSRP: £35,000
• Negotiated price (Cap Cost): £32,000
• Residual %: 55% of MSRP → £19,250
• Money Factor: 0.00150
• Term: 36 months
• Acquisition fee: £500 (capitalised)
• Initial rental (down payment): £1,500

Step 1: Adjusted Cap Cost
= Negotiated Price + Fees – Initial Rental
= £32,000 + £500 – £1,500 = £31,000

Step 2: Depreciation Fee
= (£31,000 – £19,250) ÷ 36 = £326.39/month

Step 3: Finance Fee
= (£31,000 + £19,250) × 0.00150 = £75.38/month

Step 4: Pre-Tax Payment
= £326.39 + £75.38 = £401.77

Step 5: Add VAT (20%)
= £401.77 × 1.20 = £482.12/month

Total payable over lease: £482.12 × 36 = £17,356.32

Understanding Key Lease Terms

• Money Factor: Multiply by 2,400 to estimate APR (e.g., 0.00150 × 2,400 = 3.6%).
• Residual Value: Higher residuals = lower payments. Luxury brands often have strong residuals.
• Initial Rental: In the UK, this is often 3, 6, or 9 months’ payment upfront (e.g., "3+35" = 3 payments upfront, 35 monthly).
• Excess Mileage: Typically £0.10–£0.30 per mile over allowance.
• Wear and Tear: Defined in the lease agreement; minor damage is usually acceptable.

UK-Specific Considerations

• VAT: Always applied to monthly payments (unlike some US states).
• Initial Rental: Reduces monthly payments but is non-refundable if the car is written off.
• Contract Hire: The most common personal lease type—business leases may offer VAT recovery.
• Gap Insurance: Highly recommended, as standard insurance may not cover the full lease balance.

Pro Tips & Common Mistakes

• Negotiate the cap cost first: Never accept MSRP. Treat it like a purchase.
• Avoid large initial rentals: They lower monthly payments but increase financial risk.
• Ask for the money factor: Dealers can mark it up—request the “base rate.”
• Pre-buy extra miles: If you’ll exceed your allowance, it’s cheaper to buy them upfront.
• Read the wear-and-tear guide: Document the car’s condition at handover.
• Compare total cost: Include initial rental, monthly payments, and end fees.

Practical Applications

• Budgeting: Use the formula to ensure the lease fits your monthly outgoings.
• Negotiation: Walk in with your calculated payment to counter dealer quotes.
• Lease vs. Buy: Compare total lease cost to loan + depreciation + resale value.
• Refinancing: Not possible with leases—you’re locked in for the term.