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Lease Rate Factor

Updated on January 10, 2024
Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What is the Lease Rate Factor?

The lease rate factor is the regular payment that one needs to make when an asset is taken under the lease agreement and is usually expressed as a percentage of the total price of the equipment that has been leased. Alternatively, it can be defined as the single rate factor, which, when multiplied by the cost of the leased equipment, will give the regular payment that one has to make for taking the lease.

Lease Rate Factor

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For the sake of lease rate factor calculation, suppose an equipment cost $10,000 has a lease rate factor of .0260, which 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.

Lease Rate Factor Explained

The lease rate factor is the cost of leasing assets such as equipment, vehicles, etc. It represents the monthly lease payment for every thousand dollars of the asset’s value. This is an important determinant in lease rate factor calculator and helps in comparing different leasing options.

It is often expressed in the form of decimal or percentage and is used in conjunction with the capitalized cost, the value of the leased asset. This is used to calculate the monthly lease payment using the formula.  

The setting of the rate depends on a variety of factors, such as the type of asset being leased, the creditworthiness of the lessee, and the duration of the lease can play a crucial role. Therefore, it is natural that individuals or businesses with a better credit history will secure the lease at a much lower rate in comparison to others with comparatively poor credit history.

However, the importance of comparing different leasing options based on their factors is extremely important as even the smallest of changes in monthly payments can lead to incurring significant costs in the long run.

Understanding these terms also equips the lessee to negotiate better terms and eliminates the possibility of being outsmarted by the other party in the agreement. Therefore, the lessee takes advantage of the clarity to negotiate better terms and helps them strategize and make budgetary allocations accordingly.

Types

There are two types of lease rate calculation, 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.

Formula

Let us understand the formula that shall act as a basis of our understanding of the lease rate factor calculator and its intricacies through the discussion below.

Monthly Lease Payment = Lease Rate Factor x Capitalized Cost

Here,

Lease Rate Factor = monthly payment per thousand dollars of the asset’s value.

Capitalization Cost = The value of the leased asset.

How To Calculate?

Let us understand how to calculate using the formula or get to know how a lease rate factor calculator functions through the points below.

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Examples

Let us understand the practical application of the lease rate factor calculation through the examples below.

Example #1

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.

Example #2

Increasing interest rates are driving a necessary surge in helicopter lease rates, with Russell Christopher, MD of Thora Capital, highlighting the pivotal role of interest rates in determining the 2023 business outlook. To keep pace, a 20 basis points increase in lease rate factors is deemed essential.

Thora Capital, with a strong pipeline, anticipates doubling its portfolio in the year 2024. Mike Platt, Vice Chairman of LCI, emphasizes that while demand for helicopters persists, the real challenge lies in elevated funding costs. A 1% rise in rates could necessitate an additional $8,000 monthly in rent for a typical AW139 helicopter.

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?

Now that we know so much about lease rate factor calculators and the core concept, let us also touch upon why exactly are they used through the points below.

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 does not have 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.

Recommended Articles

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 –

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