Recently, I began doing some preliminary work in search of a new SUV. I am one of those guys that loves cars and I don’t usually keep them for a long time, thus my preference for leasing.
I visited one of my favourite car dealers and a very friendly salesman helped me with the process and gave me some preliminary pricing.
I was very pleased with the Residual Value of the Car — it was very high.
Residual value is the price you would pay for the car if you choose to purchase after your lease ends. If you intend to bring the car back to the dealer after the lease ends you want the residual value to be high. This is what I intended to do. That would mean that I would pay less of the car’s depreciation while I had it.
The interest rate offered on the lease was a bit higher than I have been used to — 4.98 per cent. I have always known that interest calculations on leases were different than on car loans, but I have never actually calculated what the effects are.
I was extremely surprised when I did.
As a financial advisor I am naturally curious about all aspects of personal finance. The total interest on my scenario was much larger than I expected. I did some research, managing to download a software program that calculated car loan payments and car lease payments. Using this software I was able to duplicate the salesman numbers.
Here is a real-life example of how the interest payments are calculated in each case. If you borrow $50,000 at 4.98 per cent for 48 months the total interest on the loan is $5,248. Conversely, if you lease the same car $50,000 that has a residual value of $27,000 the total interest on the lease over 48 months is $7,792! (Source: www. calculator.net)
That surprised me, and I would suggest surprises many people.
Here is what I found out about the interest portion of a lease from www. realcartips.com
“One of the three parts of a lease payment is interest. This is where the leasing company makes a good portion of its profit. The other way it makes money is through a ‘lease acquisition fee’ and a ‘disposition fee’ at the end of the lease. The interest payment is calculated differently than what you would expect. The calculation is: (Capitalized Cost + Residual Value) × Money Factor. You read that right, it’s the cap cost plus residual value. It doesn’t seem to make sense but it’s actually an accounting method the leasing companies use to simplify things on their end.”
Food for thought when you decide on your next car acquisition.