What it means
When you lease a car, the lease starts with the gross capitalised cost, which is the agreed price of the car plus any fees rolled into the lease. A capitalised cost reduction is anything that reduces that figure.
It can be cash you pay at signing, the value of a trade-in vehicle, or a manufacturer rebate. The reduced figure is called the adjusted capitalised cost.
Your monthly payment is based on the difference between this amount and the residual value (what the car is expected to be worth at the end of the lease). The less you finance, the less depreciation you pay for.
Because the reduction lowers each monthly payment, it can be tempting to put down a large sum. However, many financial advisers caution against it.
If the car is stolen or written off in an accident early in the lease, the insurance payout normally goes to the leasing company, and your down payment may be lost. Another point is that a large upfront payment is money you could use elsewhere.
Spreading cost over monthly payments keeps your cash free for savings, emergencies or investment. Some drivers choose a smaller reduction, or none, for that reason.
The term sometimes causes confusion because of the word capitalised. It simply means that the cost is built into the lease amount rather than expensed immediately.
Always read the lease paperwork carefully to see how fees, taxes and incentives are treated, as these differ by lender and region. It is also worth comparing the lease with other ways of paying for the car.
Some lessors offer a zero-down lease where the first payment and fees are the only costs at signing. Asking for quotes with different reduction amounts lets you see the monthly payment at each level and judge whether the saving is worth the cash you give up.
In practice
Real-world examples.
Example
A buyer leasing a $42,000 sedan trades in her old car, which is valued at $5,000. The trade-in credit counts as a capitalised cost reduction. The adjusted capitalised cost falls to $37,000.
Example
A couple lease an electric vehicle and receive a $2,500 manufacturer rebate that the dealer applies at signing. The rebate counts as a reduction. Their monthly payment drops, and they pay no extra cash.
Example
A sales manager decides to put down nothing at signing. She keeps $4,000 in her savings account and accepts a slightly higher monthly payment. If the car is later written off, she has lost no down payment.
Formula
Calculation
Adjusted capitalised cost = Gross capitalised cost - Capitalised cost reduction
Monthly depreciation charge = (Adjusted capitalised cost - Residual value) / Number of months
Worked example: a car has a gross capitalised cost of $36,000, a residual value of $21,600 and a 36-month lease. The driver makes a capitalised cost reduction of $3,600.
Step 1: Adjusted capitalised cost = $36,000 - $3,600 = $32,400.
Step 2: Depreciation = $32,400 - $21,600 = $10,800.
Step 3: Monthly depreciation charge = $10,800 / 36 = $300.
Without the reduction, the charge would be ($36,000 - $21,600) / 36 = $14,400 / 36 = $400. The $3,600 down payment therefore saves $100 a month on the depreciation part of the payment, before the finance charge.Case study
Seen in the real world.
Marcus is an illustrative, fictional driver who is offered a three-year lease on a $30,000 car. The dealer suggests a $3,000 capitalised cost reduction to bring the monthly payment down. The car's residual value is $18,000.
With the reduction, the adjusted cost is $27,000 and the depreciation is $9,000 over 36 months, or $250 a month. Without it, the depreciation is $12,000, or about $333 a month. Marcus compares the $83 saving a month against the risk of losing $3,000 if the car is written off in its first year.
He chooses a $1,000 reduction and keeps the rest of his cash. The illustrative lesson is that a bigger down payment is not automatically a better deal, because it moves cost and risk to the start. She asked the dealer for three quotes with different down payments and picked the one that balanced a fair monthly payment with a modest risk.
Watch out
Common mistakes.
- Treating the capitalised cost reduction as a way to save money overall, when it only moves payments from monthly instalments to the start of the lease.
- Ignoring the risk that a large down payment can be lost if the car is stolen or written off early.
- Forgetting that rebates and trade-in values also count as reductions, and focusing only on cash.
Questions
People also ask.
Is a capitalised cost reduction the same as a down payment?
It includes a cash down payment, but it also covers trade-in credit and rebates applied to the lease.
Does it lower the interest I pay?
Yes, because the finance charge is based on the adjusted capitalised cost, so a lower amount means a lower charge.
Should I pay one?
It depends on your cash position and risk appetite, and many advisers suggest keeping the upfront amount small.
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