Knowing the terminology associated with buying and leasing a car is very important. The following terms are critical to both leasing and buying:

MSRP: This is the price that a manufacturer hopes to get for a vehicle. Remember that it is acceptable and expected that you will negotiate for most vehicles. Those who negotiate generally pay less for their vehicles than those who do not.

Capitalized cost: This is the agreed upon or negotiated cost. This amount is often significantly different from the MSRP.

Capitalized cost reduction: This is the capitalized cost that has been reduced by any rebates, incentives, and/or a trade-in vehicle.

Lease term: This is the number of months the vehicle is leased.

Money factor: This is another way of expressing the interest rate. The money factor is the APR in decimal form divided by twenty-four. It is a way of estimating your interest costs on a lease. The money factor is found by multiplying your average amount borrowed by your average interest rate; the result is your monthly interest rate, or your finance charge on the lease.

In a lease, you agree to a specific price for the vehicle, and you agree on a specific price that the vehicle will be worth at lease end. To determine the average amount borrowed over the lease term, use the following calculation:

            (Capitalized cost + residual value) / 2

If you leased a $20,000 vehicle with a $10,000 residual value (i.e., the bank-determined value of the vehicle at term end), the average amount borrowed would be $20,000 + $10,000 divided by two, or $15,000.

The average monthly interest rate is easier to determine than the average amount borrowed. The calculation is simply your annual percentage rate (APR) in decimal form divided by twelve, or APR / 12.

To find your monthly finance charge, multiply your average amount borrowed by your average monthly interest rate. Note that your capitalized cost plus the residual is your average amount borrowed, multiplied by your APR divided by 24, which is your money factor. Multiplied together, this will give you your monthly finance charge.

Residual value: This is the bank-determined expected value of the vehicle at term end. The actual value at term end may be either higher or lower than the residual value. This value is expressed as a percent of MSRP, such as 55 percent, meaning that the residual value at the end of the term would be 55 percent of the MSRP.

Taxes: In addition to paying taxes on the down payment of a lease, you must also pay taxes on your usage or depreciation charge and your interest or finance charge.

Usage or depreciation charge: This charge is the difference between your capitalized cost (after any trade-in, incentives, or reductions) and your residual value. This is the amount that you will be charged for the depreciation on the vehicle over the life of the lease.