In some loan situations, especially car leases, people like to talk about the money factor, which is a number given by
interest percentage/2400
Where does the 2400 come from? I understand that it is the universal number to use, however I would like to know why that number?
A lease payment is composed of an interest portion (borrowed money) and depreciation amount (purchase - residual).
The Monthly payment is then Monthly Interest Cost + Monthly Depreciation Cost
The Money Factor is used to estimate the amount of interest due in a single month of a lease so you can figure out the monthly payment.
If you are borrowing $100,000 then over the entire loan of repayment from a balance of $100,000 to a balance of $0, the average amount you owed was $50,000 (1/2 of principal).
You are repaying this loan monthly (1/12 of a year) and percents are expressed as decimals (1/100).
6 * 1/2 (for principal) * 1/12 (for monthly) * 1/100 (to convert percentage from 6% to .06) = 6 * 1/2400.
2400 is the product of 3 consecutive conversion (1/2 * 1/12 * 1/100) to convert from an interest rate to a money factor.
6/2400 = Money factor of 0.0025 which can be multiplied against the total amount being borrowed to know what the monthly interest would roughly equal.
Some Money Factor info: https://www.alphaleasing.com/resources/articles/MoneyFactor.asp
Alex's answer is very helpful. However, I would like to add why it might be convenient to use money factor instead of APR when computing lease payments. Money factor makes it easier to compute the lease payments manually.
Lease payments have two parts:
Here is how to calculate them:
Where,
This is a computation that anyone can perform without any tools.
I finally understood the concept of money factor. To me, two things were key:
The APR and finance charge is on the value of the ENTIRE car (not the depreciation). Due to the fact that many people define lease as buying the deprecation, I was for a long time under the impression the interest is only on the depreciated amount.
The straight line depreciation (or linear deprecation) is a key concept. When you understand it, you will understand that the average value of the ENTIRE car is equal to (Cap Cost + Residual Value)/2. The 12 is there only because APR is related to a year and money factor quoted by the car company is used to calculate the monthly fee. The 100 is there only because you want to express the APR as %.
Let's do it mathematically. Since here it is pretty difficult to use formulas I saved it as an image:
