What Is Capitalized Cost Reduction?
Capitalized cost reduction is any upfront payment that reduces the cost of financing. Capitalized cost reduction is generally associated with the purchase of a home or automobile. Reductions can be made from cash, the value of a trade-in vehicle, or through rebates.
Capitalized Cost Reduction Explained
A capitalized cost reduction is negotiated at the beginning of a financing deal and provides the buyer with an understanding of the total amount they must still pay in the future. Capitalized cost reductions can greatly help to reduce the installment payments owed from a buyer for a purchase requiring substantial capital.
A capitalized cost reduction can be used in both the leasing and purchase of a vehicle. Both scenarios are often offered to car buyers at a dealership and require careful consideration. Leasing is ultimately renting a car for the long-term and can be a more affordable option for borrowers on a tight budget. In a lease contract, the monthly payments are based on the value of the car that appreciates over the term of the contract. This allows the monthly payments to be lower since you are not paying for the full value. Down payments are typically required in lease contracts and paying a higher down payment can significantly lower the monthly leasing costs. In a car lease, the capitalized cost reduction is your down payment value subtracted from the leasing value of the car over the lease term. Payments are then divided by the number of months.
A similar scenario occurs with a car purchase however payments will be higher. A car buyer can choose to make a down payment as a capitalized cost reduction. The capitalized cost reduction reduces the total amount a car buyer will need to pay and also reduces the monthly payments. Down payments, rebates, and trade-ins may all be considered for capitalized cost reduction on a vehicle. With these negotiated reductions a car buyer can also save on interest payments by requiring a lower loan principal for financing.
Capitalized cost reductions are also common in a home purchase. Most lenders will require that a borrower pay a specified down payment of approximately 10%. The down payment goes toward the purchase of the home and reduces the total amount that a buyer must borrow for a mortgage loan. Down payment levels typically have no limit and a borrower could potentially make a 50% down payment for significant capitalized cost reduction. If a borrower makes a 50% down payment, the value they must borrower and the payments they must make over the life of the mortgage loan are substantially lower through a high initial capitalized cost reduction.