How to Convert a Money Factor to an Interest Rate

Imagine sitting with the finance manager at an automobile dealership, and she tells you that the lease you’re contemplating has a money factor of 0.002. She expects your eyes to glaze over, but instead, you multiply the number by 2,400 and announce that the lease interest rate of 4.8 percent is too high.

Impressed by your knowledge, she negotiates a lease money factor of 0.0015, which equals an interest rate of 3.6 percent when multiplied by 2,400. You shake hands, sign papers, pay some upfront fees and drive off in your new SUV.

The finance manager could offer you a lower money factor because of your excellent credit score. In other words, the interest you pay directly relates to your creditworthiness.

The story makes the point that interest rate equals money factor x 2,400. But it doesn’t clarify where the money factor originates and how it fits into the overall lease cost. That requires a bit more explaining.

Car financing, especially leasing, has its own jargon. To demystify:

• ​APR​: The annual percentage rate is a standardized way to quote the effective interest rate you’ll pay (including interest charges and financed fees) to borrow money each year.
• ​Capitalized Cost​: The amount you’re financing, typically the manufacturer's suggested retail price (MSRP) minus incentives, discounts and any down payment.
• ​Depreciation​: This is a vehicle’s loss of value over the lease term, equal to the capitalized cost minus the residual value.
• ​Lease Charge​: The total of all future payments for the entire lease period.
• ​Lease Term​: The number of months of the lease, typically 36.
• ​Money Factor​: This is an alternate way to express an interest rate and is multiplied by 2,400. The lower the factor, the less interest you’ll pay.
• ​MSRP​: The manufacturer’s suggested retail price of a vehicle. The MSRP is usually the starting point for price negotiations.
• ​Residual Value​: After the lease expires, a vehicle’s remaining value is its residual value.
• ​Tax Rate​: The rate at which your state collects sales tax.

Knowing these definitions, a car lease provider, also known as the lessor, can calculate a money factor using this formula:

​​Money Factor = Monthly Lease Charge / (Capitalized Cost + Residual Value) x Lease Term​​

Having agreed on a money factor of 0.0015, you naturally want to know how much interest you’ll pay each month. Rearranging the money factor equation gives us:

​​Monthly Lease Charge = (Capitalized Cost + Residual Value) x Money Factor​​

In this example, you wish to take a dealership’s three-year lease on an SUV with an MSRP of $36,000. The dealership uses the automobile manufacturer’s financing arm, which requires the residual value on a three-year lease to be 60 percent of its MSRP. In this case, the residual value is (.60 x $36,000), or $21,600.

Your deal includes a $2,000 dealer discount and your $1,000 down payment, giving you a capitalized cost of $33,000 (or $36,000 - $2,000 - $1,000). The monthly lease charge is therefore ($33,000 + $21,600) x 0.0015, or $81.90.

You may be perplexed as to why the one adds the residual value to the capitalized cost. The reason is that lessor pays the dealer the entire capitalized cost at lease signing and collects the residual value when someone purchases the car at lease-end.

By definition, the estimated depreciation over the lease lifetime is ($33,000 - $21,600), or $11,400. Dividing by 36, the monthly depreciation is $316.67.

In this example, your state sales tax rate is 6.75 percent.

You can calculate your monthly payment using this formula:

​​Monthly Payment = (Monthly Depreciation + Monthly Lease Charge) x (1 + Tax Rate)​​

Plugging in the numbers gives you a monthly payment equal to ($316.67 + $81.90) x (1 + 0.0675), or $425.47. Your annual lease payments will be $5,105.64.

You also must fork over some upfront money that adds to the overall cost, including the vehicle acquisition fee, the down payment and a document fee. Assume your upfront costs are $1,991.

Your total lease cost equals your total monthly payments plus the upfront costs. In this case, your total lease cost is (36 * $425.47) + $1,991, or $17,307.92.

You can purchase the vehicle at lease-end for its residual value, $21,600. If you buy it outright, your total acquisition cost will be $17,307.92 + $21,600, or $38,907.92 (assuming no lease-end fees). Your cost will be higher if you finance the purchase.