Just how much interest is included in a lease payment? It can be frustrating to be faced with a financing decision without this important piece of information. With a financial calculator, however, you can determine lease interest rates quickly.
For any loan or lease transactions, there are five basic components:
· Present Value – the amount of money you are borrowing.
· Future Value – the amount of money you will owe at the end of the lease.
· Payment – the amount of the monthly lease payment.
· Number – the number of monthly lease payments you will make over the term of the contract.
· Interest Rate – the effective rate of interest you will be paying for the lease.
Knowing any four out of these five variables will allow you to solve for the missing variable.
Let’s say you have been offered a $50,000 equipment lease with 60 monthly payments of $1,050 per month. The lease states you will turn in the equipment at the end of year five and the leasing company is giving credit for a 10% residual value. Using your financial calculator you would enter:
· PV = $45,000 (You are only “borrowing” 90% of the equipment due to the residual.)
· FV = $0
· Payment = $1,050
· Number = 60
To find the missing number, the interest rate, enter compute (usually the key says “CPT”) then the interest rate key. In this example, the rate would be 14.13%. (Note: Some old calculators provide the monthly rate. If your calculator gives you a result of 1.18, you need to multiply by 12 for the annual rate.)
Take note that residual values make a large impact on effective interest rates. If you did this same lease using $50,000 as the present value, and no residual, the interest rate comes out to only 9.5%. You should not use this rate to compare it with a loan option, however, since with an outright purchase, you would have ownership of the equipment which is worth at least $5,000 according to the leasing company’s estimate.
Keep in mind that leasing companies make money two ways — from the interest you pay and by selling or releasing the equipment you turn in. If the equipment is worth more than the estimated residual at the end of the lease, they are the big winners.
To make sure any lease you are considering is a great deal, always run it through your financial calculator’s interest rate computation, then compare that rate to your other sources of financing.