There are many unfamiliar words you may encounter -- may have already encountered -- in discussing car leasing. The explanations below may make you more comfortable with the subject.

Lease

The “lease” is a legal agreement between you and the leasing company, specifying the terms and conditions for leasing a specific vehicle. Typically, the leasing company and the dealer are not the same entity; rather, the dealer acts an agent for the leasing company. For example, if you leased a new Ford, the dealer might be XYZ Ford but the lease company might be Chase Manhattan or Ford Motor Credit.

Lease Company

The “lease company” is an institution that is purchasing the vehicle from the dealer and leasing it back to you. This may be a financial arm of one of the manufacturers, such as Ford Motor Credit, General Motors Acceptance Corp., or Toyota Motor Credit. There are, however, independent leasing companies, frequently backed by banking institutions, such as Chase Manhattan, Wells Fargo, General Electric Capital Auto Lease (GECAL), Bank of America, etc. In all cases, the lease company is buying the vehicle from the dealership and leasing it back to you for a specific period of time. The best lease company for a specific vehicle varies based on market conditions and regional availability of particular lease companies.

Lease Term

The lease term is the duration of the lease contract. 24, 36, and 48 month leases are frequently advertised, but other terms are available from some lease companies.

MSRP

“MSRP” is shorthand for “Manufacturer’s Suggested Retail Price,” sometimes referred to as “list price” or “sticker price.” It is the price that appears on the vehicle’s window sticker. The residual value of the vehicle is based on this number.

Invoice Price (Dealer Cost)

The “invoice price” theoretically represents what the dealer paid for a specific vehicle. In actuality, other discounts may result in the dealer’s true cost being significantly lower. In any event, since the invoice price is the same from dealer to dealer, it makes an excellent fixed reference point from which to compare dealer markups and markdowns and from which to calculate the lease or purchase cost of the vehicle. There is an invoice price for the base car and an invoice price for each factory installed option.

Advertising Association Fees

Dealerships will frequently belong to regional associations that handle advertising for their make of car within the region. If so, the cost of this advertising is divided among the members, and appears as a charge on the vehicle invoice. All dealers that are in the advertising association for a region will have the same advertising association fees, shown on the invoice prepared by the car’s manufacturer. Theoretically, a dealership could choose not to participate in the advertising association for its region and thus avoid these fees, but that is very rare.

Capitalized Cost

“Capitalized Cost,” often referred to as “cap cost,” should be separated into “gross” cap cost and “adjusted” cap cost. Gross cap cost includes the agreed upon price of the vehicle, any fees, extended service plans, gap insurance premiums, or other add-ons that you may be required to pay. Adjusted cap cost is the gross cap cost less any reductions by trade-in, cash downpayment, or rebates. Adjusted cap cost is the amount actually financed over the term of the lease. Many lease ads and some dealerships imply that cap cost is the same as MSRP. This is untrue. Leasing a vehicle with a cap cost of MSRP is the equivalent of buying a vehicle for full sticker price, which is much more than most customers should pay.

Capitalized Cost Reduction

This is lease-speak for a downpayment. Your combination of any cash downpayment, value of a car you trade in, and rebate you assign to the dealer, results in a reduction of the capitalized cost. The bigger your capitalized cost reduction (the more you put down), the lower the amount you will be financing and the lower your monthly payment will be.

Residual Value and End of Lease Purchase Price

“Residual value” is the value the lease company theoretically estimates that the vehicle will have at the end of the lease term. For example, a $20,000 MSRP vehicle with a residual value of 56% on a two-year lease is estimated to be worth $11,200 ($20,000 times 56% equals $11,200) at the end of those two years. The difference between the residual value and the capitalized cost is the amount of money you will have to pay off during the time of your lease (you will also have to pay a finance charge, or interest, on the amount of money the leasing company has tied up in the car). Residual values change dramatically with the term of the lease and the number of miles driven per year. Some makes and models of vehicle are known to keep their resale value better than others, and therefore have higher residual values. In addition, manufacturers sometimes agree to buy back cars at lease-end at more than the car is likely really to be worth on the market. By subsidizing the residual value in this way, the car manufacturer keeps lease payments lower than they otherwise would be in hopes of leasing more cars. Subsidizing the residual value has much the same effect as a factory-to-customer rebate would have. The residual value sometimes bears little relation to reality, but it is very important because it is used to calculate your monthly payments.

Generally, lease contracts give you the right to purchase your vehicle at the end of the lease for the residual value. For example, if the residual value will be $11,200 after two years, you’ll be able to purchase the car by paying the lease company $11,200 at the end of your two-year lease term.

Option Discount Adjustment

Car manufacturers sometimes offer special discounts on an option package, and leasing companies often treat these discounts specially in calculating a vehicle’s residual value.

For example, some vehicles might show an MSRP of $400 for a “power package.” But the invoice might also state that “prices shown are actual net prices, which include a discount of $600 retail (MSRP).” If you were leasing that vehicle, and adding up the vehicle’s total MSRP in order to make a residual value calculation, you would have to add the $600 discount back into the vehicle’s MSRP. So the MSRP for purposes of lease payment calculation would include $1000 for the power package, rather than just the discounted $400.

This peculiar piece of bookkeeping is good for you. It means your residual value will be higher -- and your payments lower -- than they otherwise would be.

Money Factor

The “money factor” is a figure used to calculate your lease payment. It roughly approximates the “annual percentage rate” (APR) of the lease when multiplied by 2400. For example, a money factor of .00336 is roughly the equivalent of an APR of 8.1% (2400 times .00336 equals 8.1). Money factors are different for different models of vehicles and lease terms, and different lease companies usually have different money factors. Everything else being equal, a lower money factor means lower payments. Leasing companies may use either money factors or APRs to express the financial terms of a lease. If a company quotes a money factor, we list both it and an estimate of the APR in Attachment A.

Annual Percentage Rate (APR)

The “APR” is the annual percentage rate of interest used in calculating lease payments. It can be converted to a money factor by dividing by 2400. For example, an APR of 8.1% is roughly equivalent to a money factor of .00336. Leasing companies may use either money factors or APRs to express the financial terms of a lease. If a lease company quotes an APR, we list both it and an estimate of the money factor in Attachment A.

Assignment Fee

Many leasing companies charge an “assignment fee,” which is essentially a processing fee. The amount varies from leasing company to leasing company. Some dealers inflate the assignment fee and keep the portion they don’t have to turn over to the leasing company as extra profit. Some leasing companies hide the assignment fee in the monthly lease finance charge calculation rather than express it as a separate fee. Mileage

Mileage

“Allowable miles” are the miles the lease allows you to drive at no additional charge. Typically this is between 12,000 and 15,000 miles per year.

“Additional contracted miles” are miles you contract for in advance, above the “allowable miles.” Additional contracted miles are contracted for, if you want them, at the time the lease is executed for an extra charge, usually expressed as cents per mile.

“Excess uncontracted miles” are miles you use above the “allowable miles” and above any additional “contracted miles” you’ve built into the lease. You are charged a penalty for excess contracted miles at the end of the lease. This penalty, usually expressed as a cents per mile charge, can be quite costly.

WARNING: Not anticipating your actual mileage needs can be very costly. Try to estimate accurately the number of miles you will drive the vehicle per year.

Disposition Fee

If you choose not to purchase the vehicle at the end of your lease, some leases charge an administrative fee, usually referred to as a “disposition fee.”

Early Termination Penalty

Most leases call for severe penalties if you end your lease before the contracted term. Make sure the lease term you choose is correct for you.

WARNING: You may have to pay a substantial charge if you end your lease early. The charge may be up to several thousand dollars. The actual charge will depend on when the lease is terminated. The earlier you end the lease, the greater this charge is likely to be. If you think there is a significant chance that you will not be able to make payments throughout the term of your lease, a lease is probably not a good option for you.

Insurance

Leased vehicles usually have stringent coverage requirements and therefore may cost more to insure than your usual “owned” vehicle.

Gap Insurance

“Gap Insurance” is for your protection in the event that your leased vehicle is stolen or totaled in an accident. From the lease companies’ point of view, total loss of the vehicle is a form of early termination of the lease. Typically, your insurance company would pay off the claim. But what happens if the market value of the vehicle is less than the amount you owe the lease company? This possible difference is known as the gap, and you would be responsible for paying it to the lease company. Some leases provide a “gap waiver,” protecting you against such an insurance shortfall if you meet certain insurance requirements, but others do not. Gap insurance covers your risk in those leases that do not offer a “gap waiver.” We feel you should always ask for and get this insurance, whether leasing from a manufacturer leasing company or an independent.

Sales, Personal Property, & Other Taxes

State and local laws vary as to how sales taxes and other applicable taxes are handled on a lease. Typically, they are calculated on the monthly payments, but several states calculate sales tax on the full purchase price of the vehicle. Additionally, some jurisdictions levy additional “local taxes” that you will be required to pay. You should check with your local taxing authorities for their tax provisions on new vehicle leases.

Security Deposit

A “security deposit,” typically one month’s lease payment rounded up to the nearest twenty-five dollars, is usually due upon execution of a lease. You are entitled to the return of the security deposit at the end of the lease unless it must be used to pay off excess charges you have incurred.

First Month’s Payment

With a lease, unlike a loan, you are expected to make your payment at the beginning of each month. So you will have to include your first month’s payment in the up-front amount you owe the dealer at the start of the lease.

Excess Wear and Tear

Lease plans have stringent requirements regarding the condition of a leased vehicle when it is returned. When available, the excess wear and tear provisions are detailed in Attachment D.

Option to Purchase

Leases typically (but not always) offer the option to purchase the vehicle at the end of the lease term. If the option is available, you are able to purchase the vehicle at a predetermined price (frequently the residual value of the vehicle) or at market value (this value may be computed by using one or more market “guides” such as “Blue Book” or “N.A.D.A.”) plus any applicable purchase option fee. In either valuation method, this is a purchase “option.” You can always return the vehicle at the end of the lease if you do not wish to buy it. A purchase option fee is required by many plans.