You will either be thinking about leasing a vehicle or preparing to lease one if you are reading this, so you may be wondering just exactly how those car leasing monthly payments that you are due to pay are arrived at.
So we will concentrate on this option.
The following factors are taken into consideration at the start:
THEN, the length of the contract period (2,3 or 4 years are normal) is used to spread the cost over the months, and interest is likely to be added to (because, after all, this is still a loan to you).
Remember that, during the time of the contract, you never technically own the vehicle. Throughout the entirety of the leasing process, the vehicle remains the property of the finance company.
And you should treat it as such, because at the end of the lease, you will be giving the vehicle back for them to sell on to a dealer or private buyer.
This is why there is a Fair Wear and Tear policy, (and charges if this is not adhered to) and an Excess Mileage charge if you exceed the agreed mileage, worked out on a 'pence per mile' basis as set at the start of the contract
It also explains why all vehicles need to be insured with full comprehensive cover in case of accidents.
As Real Cars explains in their detailed article explaining leasing costs (in the USA, but they are relevant here too), "when you lease a car, a leasing/finance company actually buys the vehicle from the dealer before leasing it out to you."
And that leasing/finance company are not just doing it because they like you and want you to have a shiny nice new car to drive about in; they expect to earn interest on the money they used to buy the car (just like a loan). And they fully understand that, at the end of the lease, that car will be worth a lot less than it was at the start because it has greater mileage, has been used, and is subject to depreciation.
Cost of the vehicle
And then, if any optional extras are added to the car, these need costing in too.
Then there is the depreciation to take into consideration as it used as part of the calculation when it comes to the anticipated residual value of the vehicle - just how much the vehicle is likely to be worth at the end of the contract.
Our guide here explains exactly what is involved in vehicle depreciation, but basically "depreciation is the difference between the amount you spend when you buy a vehicle and the amount you receive when you sell it."
According to the AA, "an average new car running at 10,000 miles a year will have a residual value of around 40% of its new price after three years."
Depreciation is affected in different ways depending on types of cars, market forces, age, fuel efficiency, model updating, car colour, fashion forces, rival model updating, supply and demand, mileage, and car condition upon return from leasing. Some affects are avoidable (such as car condition and mileage) and some are not.
So car experts calculate just how much value a car is likely to use over the length of the contract, and this loss is spread over the months as part of the monthly payment - and in fact, makes up the majority of that payment.
With depreciation affected by mileage, the agreed mileage at the start of the contract needs to be kept to, because if it is exceeded, the value of the car goes down - hence penalty payments due for exceeding it.
Length of contract
The longer the contract, the cheaper the monthly payments are. BUT it also means that the car is older by the time the contract ends, has depreciated more, and is worth less. So longer contract periods do not necessarily mean a great change in payments. Noticable? Yes. But a lot? Not necessarily.
You could take out a Maintenance Contract which covers repairs (to an extent), and the cost for this has to be added into the monthly payments too.
The next part of the lease payment is interest. After all, you are renting a new car, and a finance company has 'bought it for you', and if you bought it yourself you would probably have to pay interest too.
So it's fair that they charge you interest.
Add all these things up, and you get your monthly payment.