What is the Lease Rate Factor?

Suppose an equipment of cost $10,000 has a lease rate factor of .0260, it means a monthly payment of (10,000 *.0260) = $260. It means that the lessee must pay $260 for leasing the equipment in consideration of the required number of periods, which is set in the leaseLeaseLeasing is an arrangement in which the asset’s right is transferred to another person without transferring the ownership. In simple terms, it means giving the asset on hire or rent. The person who gives the asset is “Lessor,” the person who takes the asset on rent is “Lessee.”read more agreement.

Types

There are two types, generally explained as car/equipment lease and space lease rate factor. In-car and equipment leasing, the company which leases out the objects primarily purchases the car or equipment from third-party dealers or agents and provides us the same on rent. It means that we are paying for the loan the lessorThe Loan The LessorA lessor is an individual or entity that leases out an asset such as land, house or machinery to another person or organization for a certain period.read more has borne to purchase the item by lending money upfront to buy the car/equipment.

  • At times, the car provider and lessor can be a single entity where a third-party contract allows the car provider to sell stock to the lessor. Further, this is used to produce revenue on these assets/objects before transferring the car/equipment back to its provider as used items. On the other hand, the lesseeThe LesseeA Lessee, also called a Tenant, is an individual (or entity) who rents the land or property (generally immovable) from a lessor (property owner) under a legal lease agreement. read more gets the object they can use even without being the owner or bearing the pressure of owning it.When it comes to real estate, the prime purpose is to generate rental income from the tenants. Thus, only two parties get involved in this mode of execution, and any reimbursementReimbursementReimbursement refers to the monetary compensation made by companies, organizations, or governments to employees, customers, taxpayers, or other entities for incurring expenses out of their pocket.read more for the application of funds into the real estate is covered up in the leasing rate as the strategy of the entire business setup.

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Lease Rate Factor (wallstreetmojo.com)

How is it Calculate?

  • The first and foremost thing considered is the equipment value and the depreciation rateDepreciation RateThe depreciation rate is the percent rate at which an asset depreciates during its estimated useful life. It can also be defined as the percentage of a company’s long-term investment in an asset that the firm claims as a tax-deductible expense throughout the asset’s useful life.read more before we calculate the lease rate factor. The calculation of the equipment value also has a methodology associated with it. Suppose we are leasing equipmentLeasing EquipmentEquipment Lease is where the equipment owner allows another party to use it in exchange of periodic rentals with no transfer of ownership and has the right to cancel the lease right away in case of breach of the lease agreement.read more whose retail price if we purchase new is $70,000 and has a useful lifeA Useful LifeUseful life is the estimated time period for which the asset is expected to be functional and can be put to use for the company’s core operations. It serves as an important input for calculating depreciation for assets which affects the profitability and carrying value of the assets.read more of 10 years. That means after applying depreciation over ten years, the residual value stands to be $10,000. Then the equipment value for leasing stands to be $70,000- $10,000 = $60,000.Now coming to the calculation of depreciation part, here we have seen the equipment value on the grounds of leasing stands to be $60,000, and suppose the lease term has been set to 5 years. Thus, the depreciation part of the lease paymentLease PaymentLease payments are the payments where the lessee under the lease agreement has to pay monthly fixed rental for using the asset to the lessor. The ownership of such an asset is generally taken back by the owner after the lease term expiration.read more to be made monthly will stand at $60,000/60 = $1,000.Coming to this calculation, let us, for example, consider the annual rate of interest to be 5% per annum. It is calculated by dividing the interest rate by the months considered for leasing. So here it will be (0.05/60) = 0.008.So finally, to arrive at the monthly amount to be paid for the lease, we need first to calculate the interest payment, which is calculated as follows: ($70,000+$10,000) *0.008 = $640.  The total payment must be made in the depreciation part too, and thus it makes $1,000+$640 = $1,640.

Example

Let us take an example of a piece of machinery used to produce toys that have been leased for five years with a lease rate factor of 0.008. It means considering the annual interest rate in the market as 5%; the factor has been calculated by dividing the interest rateInterest RateAn interest rate formula is used to calculate loan repayment amounts as well as interest earned on fixed deposits, mutual funds, and other investments. It is also used to calculate credit card interest.read more by the number of years the lease is concerned. i.e. 0.05/60 = 0.008. For calculating the interest payment, the market value of the equipment plus the residual valueResidual ValueResidual value is the estimated scrap value of an asset at the end of its lease or useful life, also known as the salvage value. It represents the amount of value the owner will obtain or expect to get eventually when the asset is disposed.read more is added and multiplied by the lease factor.

Lease Rate Factor Conversion to Interest Rate

Considering both interest rate and the lease factor is very important when we want to check which is costing us less, i.e., whether going into a lease agreement is beneficial to buying equipment where interest payment on loans comes into the picture. A very important number that comes into this comparison is 2400, multiplied by the lease rate factor to arrive at the interest rate.  An example of this can suppose we have a lease rate factor of 0.003, as mentioned above; when we want to convert it to the interest rate, we multiply the factor by 2400, i.e., 0.003*2400 = 7.2%. Thus, the annual interest rate comes to be 7.2% when the leasing factor is used in 0.003. To cross verify this calculation, we can again do a reverse calculation, i.e., 7.2/2400 = 0.003

Why Are They Used?

  • There is constant debate about when to lease space/equipment and own the entire thing. The main factor which plays an important role in leasing is the time and time value of money. In simple words, we need to consider how long we will use the leased property.To minimize the residual/sunk cost when the demand for certain equipment is only meant for a short-term basis, leasing is the ideal decision. These can be operational requirements needed for expansion or growth coupled with temporary market conditions. At this point, leasing is an idle scenario because it reduces the burden of owning the equipment as a whole and thus ends up with a huge sunk costSunk CostSunk costs are all costs incurred by the firm in the past with no hope of recovery in the future and are not considered while making any decisions since these costs will not change regardless of the decision’s outcome.read more at the end.Also, when a company does not want to focus on non-core business issues like equipment and property maintenance, leasing can be an option as it removes the burden of owning the same and maintaining it.

Lease Rate Factor vs. Interest Rate

Lease factors can, at times, make very costly loans look cheaper. The lease rate factor has a money factor instead of an interest rate, whereas an interest rate factor has a percentage rate of interest calculated annually. When we want to convert the money factor or lease rate factor to interest rate, we need to multiply the same with 2400. In the loan agreement where interest rate comes into the picture, the asset owner must bear both the charges of the loan and interest and the asset’s residual value. Here, the asset user needs not to hold the asset with them till it reaches its residual value; thus, cost savings can be brought in.

Conclusion

It is very important to understand and estimate the overall payment, which needs to be made for the lease, or else the lessor can easily add a few extra amounts, and the lessee will not even come to know about it. A small extra amount added every month unknowingly can be a big number at the end of the lease period. It helps us to understand the overall cost of leasing. The interest rate may change depending on the market scenarios, but once agreed, the lease rate factor remains fixed for the rest of the lease term.

This article has been a guide to What is Lease Rate Factor & its Definition. Here we discuss how to calculate the lease rate factor and types, along with examples and why it’s used. You can learn more about it from the following articles –

  • Lease ExtensionLeveraged LeaseGround LeaseModified Gross Lease