Understanding Your Auto Lease Contract: A Comprehensive Guide

by Justin Fischer | Sep 18, 2023 | Leasing

The last time a car commercial grabbed your attention with an attractive lease deal, you were probably bombarded with a flurry of rates, payments, and terms squeezed into a mere thirty seconds. So, what exactly is a car lease?

An auto lease is a long-term rental agreement for a vehicle, governed by specific terms and conditions. The lease terms are mutually decided by the customer and dealership (or automaker in the case of companies like Tesla, Rivian, and Lucid). Intriguingly, a third-party leasing company takes actual ownership of the vehicle and then leases it to you.

Let’s dissect a vehicle lease agreement into its four primary components:

• The Capitalized Cost
• The Residual Value of the Vehicle
• The Money Factor
• The State Sales Tax

These core factors dictate the overall cost of the lease, subsequently influencing your monthly payment.

Let’s take a closer look at each of these four parts of an auto lease. Once we’ve covered the basics, we’ll familiarize you with the parts of a lease contract, so you know exactly what you’re getting into! Skip ahead to the example here if you like.

The Four Parts of a Car Lease

1. Cap Cost (Capitalized Cost)

The cap cost diverges from the out-the-door price, which integrates the vehicle price with all taxes and fees. Instead, you negotiate the cap cost during a lease, representing the sum the leasing company pays for the car. This figure typically includes:

• Negotiated selling price
• Documentation fee
• Miscellaneous charges
• Additional add-ons or services

It’s important to note that some of these expenses, like security etching or nitrogen-inflated tires, are negotiable. To provide context: a $1,000 increase in cap cost approximates to an additional $27 monthly on a 36-month lease.

Before committing, scrutinize every detail of the buyer’s order, distinguishing legitimate fees from the negotiable ones.

We’ll take a look at the parts of an auto lease contract in a bit, or you can skip ahead to it here.

2. Residual Value

This value mirrors the car’s projected worth at the end of the lease. Depreciation during the lease term is what you’re paying for. If, for instance, the residual on a 36-month lease stands at .75 (75%), you’re essentially covering the 25% anticipated depreciation over that period.

Residual values, set by the leasing company, vary depending on the yearly mileage you’re permitted (standard figures being 7,500, 10,000, 12,000, or 15,000 miles). Dealerships cannot modify these values, with the sole exception being adjustments for additional allowed mileage. This residual is disclosed, highlighting what you’d need to pay if you wish to purchase the vehicle at the lease’s end.

3. The Money Factor

Similar to an interest rate on a car loan, the money factor can be marked up, benefiting the dealer. Dealers typically receive a money factor (for instance, .00125) from a lender, and might mark it up by 50 to 100 basis points. The disparity between this base rate and the marked-up rate translates into profit for the dealer. 

Pro Tip: Always aim to haggle the money factor close to its buy rate.

4. Sales Tax

Sales tax varies state-by-state. See your state’s tax rates here. While most states append the tax to the lease’s total price, others like New York, New Jersey, Minnesota, Ohio, and Georgia impose it upfront on the overall lease payments. Virginia, Maryland, and Texas, on the other hand, tax the total selling price (cap cost). Though non-negotiable, understanding your state’s tax nuances is crucial for understanding what you can afford in any car deal.

Understanding Your Car Lease: A Real-World Example

There’s no better way to learn than to work through a real example. That’s exactly what we’re about to do by breaking down the parts of a real auto lease contract. 

In this image, we can see the first few lines of a lease contract. Expect this portion to contain the contact information for you and the lessor, who is the dealer. There will also be information about the specific vehicle you are leasing. Make sure the VIN number matches the car you want! If you have a trade-in, that information will be listed here too.

The next part of your vehicle lease agreement includes some very important information. First, check the ‘Amount due at lease signing’, which is box #2 in our example. Does it match the deal you’re expecting?

Now let’s move on to box #3. Check the box for the remaining months of payments after the first payment. This number should say 23 if you’re signing a 24 month lease, 35 if you’re signing a 36 month lease, and so on. This is how you confirm that you’re getting credit for the first month’s payment, which is due at signing in most cases.

Below that, you’ll see an itemized list of what you’re paying at lease signing. Pay attention to the details in section 6. 

You should see the license, title, registration and tax fees listed. You’ll also see the Doc Fee, which varies by state.

Watch Out For Add-Ons

Pay careful attention to the line items that may be dealer add-ons that you don’t want. In section 6 in our example, lines A.11 through A.13 are where we would see this.

Section 6.B line #2 is where you would see any rebates or incentives you’re expecting. If you’re expecting an electric vehicle tax credit, for example, it should be shown here.

Now, make sure the ‘Total’ number equals what you expect.

The above section explains how your monthly payments are calculated. It can be tough to follow, but we’ll highlight which parts are most important to double-check.

Are There Markups?

Section 7.A is the total price of the vehicle, which should be MSRP, or ideally discounted from MSRP, plus any additional fees you agree to. 

In this example, the total price includes the agreed upon selling price of $57,409 plus the acquisition fee of $650 and the electronic filing fee of $33 for  total price of $58,092.

Double check this number. If the gross capitalized cost is higher than you’re expecting, find out why. Is there a dealer markup on the vehicle? You’re paying more than you should if so.

What is a ‘rent charge’, you ask? The rent charge is the total interest that is paid during the term of the lease. The rent charge is based on the agreed upon money factor used in the lease calculation.

Ensure that the allowed mileage matches what you expect. Learn what the excess mileage rate is if you exceed the limit.

Towards the end of this section, you’ll see the ‘total monthly payment’. Is this what you expect? This is how much you’re agreeing to pay every month. 

Double Check Your Numbers

You need to make sure that the discounted selling price that you negotiated matches line A in section 11. Section 11 line B will also list any accessories or options that you have agreed to be added to the selling price, such as excess wear and tear protection, tire and wheel insurance or even a service contract. Please make sure that nothing has been added that you have not agreed to.

Read the first line in bold. You do NOT have to purchase add-ons or protection products to enter into the lease. No matter how hard the salesperson pitches their value, remember that you can say no. If you do agree to any, they should be listed here. 

The total taxes to be paid for the lease are included. Make sure this number is what you expect. Taxes and state fees are estimated because if the state increases the sales tax rate or vehicle registration rates during the term of your lease agreement you will have to pay the new rates and fees.

Below these first few pages of the car lease agreement, you’ll have standard disclosures for your auto insurance policy information, vehicle warranties, and additional terms and conditions. Wondering what happens if your leased car gets stolen? You’ll find that information here. 

Lease Terms Are Negotiable!

Every week, our team of Car Coaches helps hundreds of drivers negotiate the best lease terms. It’s a commonly held misconception that leases aren’t negotiable, but that’s far from the truth. With basic knowledge of how to navigate an auto lease contract, you can stay in control of your deal. 

Ready to work with an auto industry insider for the most savings? Here’s how we can help. 

We also have hundreds of free resources, including these reader favorites:

• The Best Lease Deals This Month
• What to Do At the End Of Your Lease
• The Most and Least Negotiable Cars

Stop by the CarEdge Community forum! We’d love to see you there.