Let me guess, this is the first time you’ve ever leased a car, or considered to lease one. There is one term that you’ve probably heard of, and it is the main part of any lease contract. The MONEY FACTOR. This is one of the main parameters in determining your car lease payments.
Ok, let’s see what exactly the money factor is. First of all you need to know that a car lease isn’t that different from actually purchasing a car and selling it a couple of years later. The concept is quite similar. Picture this: you purchased a brand new car, it’s yours. You’re using it, driving it around for a couple of years. This period of time during which you’ve used car is called “depreciation” and it decreases the value of the vehicle considerably (especially in new cars where in the first year 30% of its value is lots). Then you decide to sell the vehicle. Naturally it will be worth a lot less. The exact same thing happens during a lease. By using it, you’ve depreciated the car’s value so after three years of lease you’re returning a used car to the dealership.
This lost value is crucial, because the amount of depreciation, combined with the money factor are the two most important concepts that come with leasing a car.
Most cars can be driven a long long time, as long as you have enough money to pay for the repairs. But as the car ages, the necessary repairs become more expensive since all the components are slowly deteriorating. When a car has reached this “checkpoint” it means that its life as a useful vehicle is over and all the value has been consumed from the vehicle. This is the idea that defines depreciation.
In order to determine the monthly payments for the lease, the dealership has to predict the amount of depreciation the car will suffer during the time it is used by a lessee, so that they can know how much will the car be worth at the end of the lease contract. Since most contracts are usually made for two or three years, a good indicator is the number of miles a vehicle acquires and its age. That’s why a dealership places a mileage limit for each year, to make sure their investment is protected. This mileage cap is usually if 10.000 miles. Each mile drove over this limit can bring steep fees upon you (each miles can be charged with 20 cents).
You must realize by now that when you lease a car you don’t actually own it. It’s more like a long time rent. The dealership is the one with the ownership title in hand. Since the dealership is giving you the possession of a $20.000 asset, while agreeing to receive monthly payments for it, they are susceptible to the risk of non payments.
This is where the money factor actually comes into play. As we’ve said before, the money factor is the compensation for the risk of nonpayment which they expose themselves to when making a contract with the lessee. This is means that they are losing the opportunity to divert the money paid for the car which you’re currently leasing.
You can actually compare the money factor to the APR (Annual Percentage Rate), usually encountered when getting a car loan. If you multiply the money factor by 2400 you obtain the interest rate. And vice versa: if you divide the interest rate by 2400 you obtain the money factor.
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