There are lots of reasons a business owner might choose to lease equipment instead of purchasing it. Sometimes, the business owner simply cannot afford to buy the equipment outright, which is often the case for a smaller business or an entrepreneur who is just starting out. In other cases, it is because the equipment has a short lifespan, and leasing it is a way to avoid losing money by purchasing equipment that will be obsolete soon. When a business owner opts to lease equipment, he signs a lease agreement with the equipment's owner. This allows him to use it for a specified period of time, known as the lease term. For the privilege of using the equipment without actually owning it, the lessee's rental fee includes the lease money factor, a financing rate that makes it possible for the equipment's owner to profit from the lease.
Purpose of Lease Money Factor
The lease money factor is sometimes referred to as the lease factor or even just the factor. This is the amount of money the equipment owner charges the lessee in financing each month over the course of the lease's term. The lease money factor is not the rental amount the lessee pays but the factor used to determine the interest rate she pays. For example, a lease money factor of 5.4 percent may be applied to a lease, which means the lessee pays a monthly rate of 0.00225. (This caculation is explained in more detail below.)
Lease Money Factor to Interest Rate
Many people confuse a rental's lease money factor with its interest rate. Though the two are similar and interconnected, they are not the same. The lease money factor is used to determine the interest rate on a rental.
Using the money lease factor to calculate a rental's interest rate can help a prospective lessee determine whether leasing or buying a piece of equipment is the better deal financially. That said, he should always consider all relevant factors involved in a potential lease or purchase, like maintenance costs, the equipment's obsolescence and the perks the equipment owner offers with the rental, like transportation and maintenance.
Calculate Monthly Finance Fee
A lease agreement also lists a figure titled the "lease charge." This figure is the total finance charges applied over the course of the lease, and it is calculated using the lease money factor. By dividing this figure by the number of payments over the lease term, the lessee can find the monthly finance fee.
For example, a five-year car lease might list the lease charge as $18,000. Divided over 60 months, this comes out to a monthly finance fee of $300 per month.
Calculate Lease Money Factor
You can find a lease's lease money factor by using the following formula, which incorporates the lease charge, the net capital cost and the equipment's residual value. The residual value is the equipment's value at the end of the lease's term, and the net capital cost is its cost at the beginning.
LMF = LC / ((NCC + RV) x P)
LMF = Lease Money Factor
NCC = Net Capital Cost
RV = Residual Value
P = Number of payments during lease term
In this example, the equipment has a net capital cost of $120,000 and a residual value of $30,000 at the end of the lease. The lease's term is for 60 monthly payments with a lease charge of $18,000.
LMF = 18,000/((120,000 + 30,000) x 60)
= 18,000/(150,000 x 60)
Find the annual interest rate by multiplying the LMF by 2,400 to find the annual interest rate.
Interest rate = 0.0020 x 2,400 = 4.8 percent