Why Residual Value Matters
One of the biggest issues in the car leasing industry is jargon. There are so many words and phrases that mean something to the dealer but may not make sense to the person leasing the car. In high-pressure situations, a buyer may be less willing to ask questions about what these terms actually mean.
One of those terms is “residual value.” Let’s break down what this means. A residual is a part left over after something has been taken away. So if you have 10 apples and someone takes 6 of them, then the residual is 4 apples. This works in car leasing in relation to the value of the car left over after the lease ends.
This term comes from the idea that you are paying for the value of the vehicle lost during the lease. As depreciation occurs, the value of the car decreases. Therefore at the end of the lease there must be some value left over, this is the residual value.
Here’s a more specific example of what you can expect from a residual value calculation. Let’s start with a leased vehicle with a manufacturer’s suggested retail price (MSRP) of $20,000 for a three-year lease term, and this vehicle had a 60% residual value. This means the value of the lease should be 60% of the original MSRP at the end of the lease (60% of $20,000 is $12,000). The difference between the selling price and the residual is what makes up the bulk of your lease payment.
In this example, we purchased the full MSRP for the vehicle. The lease payments are based on the difference between the selling price ($20,000) and the residual ($12,000). This $8,000 difference would be divided over your 36-month lease — $8,000 divided by 36 months nets you a base payment of $222. Taxes, interest, and fees would be added to this base payment to give you your overall payment.
Residual value: 60%
60% of $20,000 = $12,000
Selling price: $20,000
Selling price minus residual value: $20,000 – $12,000 = $8,000 (← this $8,000 is the depreciation amount and is the basis for your lease)
Lease length: 36 months
$8,000 divided by 36 months = $222.22 per month base payment (before taxes, fees, etc.)
The Bottom Line
You can come to a pretty clear understanding of what your monthly payments will be like when you compare the residual value of a vehicle after a 3-5 year period of time and it’s current MSRP. This can be valuable information when it comes down to negotiation.
If you’re dealing with someone who is trying to charge you a bit more for your monthly payments than you need to be, you are now armed with the calculation necessary to be properly informed. But, as we talked about above, you must also include any taxes or fees unique to your dealership or state.
You can also use your knowledge of residual value to choose the best car for your lease. Some cars will hold their value better than others. So cars you may think are out of your price range may actually hold their value better than a cheaper car.
If this is still not clear, please reach out to us at carvoy.com. We are happy to work with you on a one-on-one level to make sure you are completely informed before signing any contract.