Car lease terms explained: cap cost, residual and money factor

Leasing means paying to use a car for a set time and mileage, not buying it. The FTC explains that your payments cover the car's expected loss in value during the lease, plus a rent charge, taxes and fees. Once you know where each of those numbers sits on the paperwork, a lease offer gets much easier to compare.

In the US, the federal Consumer Leasing Act and its rule, Regulation M, set out what a vehicle lease must disclose. The terms below use the labels Regulation M requires, so you should find them on most US lease contracts.

The payment calculation, line by line

Regulation M requires a step-by-step breakdown of how your monthly payment was worked out. Here it is with a sample lease from fictional Northgate Motors, 36 months:

• Gross capitalized cost: $34,000. The agreed value of the vehicle plus anything else rolled into the lease, such as fees or a service contract. This is the number to negotiate, just as you would the price of a car you buy.

• Capitalized cost reduction: $2,000. Anything that lowers the gross capitalized cost: a cash down payment, net trade-in, rebate or credit.

• Adjusted capitalized cost: $32,000. The gross figure minus the reduction. Regulation M describes it as the amount used to calculate your base payment.

• Residual value: $19,800. The value of the car at the end of the lease used in the calculation.

• Depreciation and amortized amounts: $12,200. The adjusted capitalized cost minus the residual value. This is what you pay for the car's decline in value.

• Rent charge: $3,960. The amount charged on top of depreciation, which works like the finance cost of the lease.

• Total of base payments: $16,160. Depreciation plus rent charge.

• Base monthly payment: $448.89. The total of base payments divided by 36. Tax is added on top.

If the numbers do not add up the same way on your own lease, ask the dealer to walk you through each line.

What is a money factor?

Dealers often quote a lease's finance cost as a "money factor," a small decimal such as 0.00165. It is a way of expressing the rent charge. The term does not appear in the federal disclosure rules, which show the rent charge in dollars instead.

Regulation M also says that if a lessor states a percentage rate, it must add a notice that the percentage "may not measure the overall cost of financing this lease," and it cannot call it an annual percentage rate. So when you compare offers, compare the rent charge in dollars and the total of payments, not just the money factor or a quoted rate. If a dealer gives you a money factor, ask for the rent charge it produces on this lease, in writing.

Other figures on a US lease

• Amount due at lease signing or delivery: an itemized list of everything you pay up front, such as the first payment, cap cost reduction, fees and taxes.

• Total of payments: what you will have paid by the end of the lease.

• Official fees and taxes: the total of registration, title, license fees and taxes.

• Purchase option: whether you can buy the car at the end, and for how much. If there is no option, the lease must say so.

The warnings to read twice

Regulation M requires two notices in plain language. The early termination notice reads: "You may have to pay a substantial charge if you end this lease early. The charge may be up to several thousand dollars." It adds that the earlier you end the lease, the greater the charge is likely to be. Look for the section that explains how that charge is calculated.

The excess wear notice says you may be charged for wear beyond the lessor's standards for normal use, and the lease must state the charge or method for excess mileage. The FTC notes that many standard leases cap mileage at 15,000 miles a year or less. Compare the allowance with the miles you drive now, and write down the per-mile charge.

Open-end and closed-end leases

In a closed-end lease, you return the car and pay any wear, mileage or other charges the contract lists. In an open-end lease, you may owe more at the end if the car is worth less than the residual value. Regulation M requires an open-end lease to say so. Check which type you have.

If you are leasing in Canada

FCAC says car leases are covered by provincial and territorial consumer protection laws, and most provinces and territories require the dealer to give you a disclosure statement before you agree to lease. That statement explains the total cost of leasing and your obligations under the agreement. The labels may differ from US contracts, so look for the same building blocks: the agreed value, any down payment, the residual value, the lease charge, the term and the mileage limit.

Questions to ask before you sign a lease

• What is the gross capitalized cost, and what is included in it besides the car?

• What is the residual value, and is this a closed-end lease?

• What is the rent charge in dollars over the whole lease?

• How many miles or kilometers a year are included, and what does each extra one cost?

• How is the early termination charge worked out?

• What is the purchase option price at the end?

If you are deciding between leasing and buying, compare the total cost of each over the time you expect to keep the car. Our guide on working out the out-the-door price covers the purchase side.

Get a second pair of eyes on your lease offer

When EasyToDecode opens, you will be able to upload a lease offer or contract and see the capitalized cost, residual value, rent charge, fees and mileage terms pulled out and quoted from your paperwork, with questions ready to send the dealer. See how it works or join the waitlist.