By the way, for anyone who has enjoyed watching me twist myself into knots trying to explain leasing, and getting it wrong in an earlier post, I did figure something out that I think is worth posting, not just because I was annoyed I didn't understand it at first, but also because I think it's really freaking obscure and I honestly don't think the right answer is anywhere out there on the internet. There's a TON of misinformation about Money Factor - even ChatGPT has it wrong and I corrected ChatGPT and it kept backpedaling on me. So, just for the record, here is the lowdown:
It is a universally accepted fact that Money Factor = Equivalent APR divided by 2400. But why 2400? Most sources on the web say it's a way to convert a %age to a monthly number. This is halfway true, but only halfway. It makes sense that if an APR is, say, 6.5%, you have to divide by 100 to get to a decimal. 6.5 -> .065. Great, so we've explained why we have to divide by 100.
Then you have to divide that answer by 12, because there are 12 months in a year, and what we're using Money Factor to do is calculate a MONTHLY (not annual) interest portion of a payment. Great, so we've explained why we also have to divide by 12. We've now divided by 100, then divided by 12, which is the same as taking the original number and dividing by 100 x 12 = 1200.
So then, how do we get to 2400? (btw, most lease explainer sites are silent on why 2400 vs. 1200, and some even claim it's because lease payments are compounded monthly, which is false, but wouldn't even explain how to get to 2400 anyways). The answer is that it's an arbitrary convention based on the multiplier that is used as the basis for the monthly payment. To calculate a monthly interest portion, the conventional equation used by leasing companies is:
Interest Portion of Monthly Payment = Money Factor x (Residual Value + Total Capitalized Cost)
You'll note that Residual + TCC is much more than the cost of the vehicle. Imagine a $100K car with a $60K residual - that sum is $160K. But nobody is actually borrowing $160K. What we're really borrowing is:
- On day 1 of the lease, the leasing company is spending $100K to buy the whole car, so we have to borrow the $100K from them to take possession of the car.
- In successive months of the lease, we are paying down this $100K little by little, in equal increments, so after 1 payment we're now borrowing a little less than $100K.
- All the way until the last day of the lease, at which point we've paid down the principle down to the residual. So on the very last day of the lease, we're still borrowing $60K.
Thus, over the course of the lease, we start out borrowing $100K and whittle that down to $60K. On average, over the course of the lease, we'd have borrowed $80K. How do we calculate the average of two numbers? We add them, then divide by 2.
I think a normal person would calculate the interest portion of the payments as:
Interest Portion of Monthly Payment = (APR/1200) x ((Residual Value + Total Capitalized Cost)/2)
This makes sense to me. Apparently it didn't to the people who write leases. So they took the 2 that I have bolded above, and moved it to the part of the equation where the APR is. So, it's equivalent to say:
Interest Portion of Monthly Payment = (APR/1200)/2 x (Residual Value + Total Capitalized Cost)
Then, they took the (APR/1200)/2, (which equals APR/2400), waved a magic wand, and called it Money Factor.
In short, the reason you divide by two is that's required to average the outstanding principal balance, and instead of averaging the outstanding principal balance, they decided to sum the components of the average principal balance and move the averaging factor over to the interest multiplier.
QED, F leasing and the explanations on the internet.
