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When it comes to leasing a car, the vehicle’s residual value is key. But what is residual value — and why is it important?
The residual value is set at the start of your lease by the leasing company, which may be the car dealership or another financer. It’s the anticipated value of the car at the end of the lease and is used to determine your monthly lease payments. If you decide to buy your leased car, the price is the residual value plus any fees.
Keep reading to find out how lease issuers decide a car’s residual value, and what you should understand about it when considering any lease deal.
- What is residual value of a car?
- Can I negotiate my car’s residual value?
- Should I buy my leased car for the residual value?
- How residual value affects different kinds of leases
What is residual value of a car?
Leasing a car is kind of like renting a vehicle for a set amount of time. The difference with a lease is that the lion’s share of your monthly payment is for the cost of vehicle depreciation.
Your car’s value at the end of the lease is what’s referred to as its residual value. It’s essentially the value of the vehicle after depreciation.
How is residual value in a car lease determined?
The leasing company determines your car’s residual value by considering multiple factors and market conditions, including the car’s perceived reliability, safety and resale value. New technological advances, gas price fluctuations and general economic conditions can all affect your car’s residual value, too.
The residual value can be expressed as a percentage of the price. For example, if it’s estimated at 60% of the initial price of the vehicle, the residual value of a $50,000 vehicle would be $30,000.
Can I negotiate my car’s residual value?
By law, if lease buyout is an option the leasing company must disclose the residual value of the vehicle when you lease your car. In fact, every lease where buyout is available will specifically include the residual value of the vehicle. But you typically can’t negotiate it like you can with other lease terms (although you can try).
Still, residual value is something you should think about when you’re considering whether the terms of a car lease make sense to you and something you can ask about as you shop around.
A higher residual value means the car is expected to hold its value well (depreciate less) over the lease term. Remember, most of your lease payment covers the cost of depreciation. So less depreciation (or higher residual value) can mean lower monthly payments over the lease term.
So is the rule that the higher the residual value, the better? Not always. If the residual value is set higher than what the car will really be worth at the end of the lease term, and you plan on buying the car at the end of your lease, you could wind up overpaying for the vehicle if you do buy it.
Should I buy my leased car for the residual value?
It’s typical for a lease agreement to have an option to buy the vehicle for its residual value when the lease ends. If your car is actually worth more than its estimated residual value, that would make it a great deal.
Say your car’s residual value is $10,000, but its value at lease end is $15,000. You may consider taking a chance by buying the car at lease end and then trying to sell it for that higher price tag to pocket the difference. Or you can just keep driving your purchased car, knowing you’ve gotten more than your money’s worth.
How residual value affects different kinds of leases
How residual value works at the end of your lease can depend on the kind of lease you have. In certain cases, you could end up owing money when your lease is up and you turn the car in.
- Closed-end leases — With a closed-end lease, if the car ends up being worth less than the residual value when the lease is up, you can still turn the car in and walk away with no obligation other than to pay what you’ve promised to pay for things like mileage overages.
- Open-ended leases — At the end of an open-ended lease, if the car is worth less than its residual value, don’t expect to just hand over the keys and walk away. You may have to pay the difference between the residual value of the car and the fair market value of the car.
In both cases, if you have the option in your lease you can also choose to buy the car. Whether it’s wise to pay more for a car than it’s worth at the end of a lease is another question, of course.
When considering a car lease, it’s important to understand your vehicle’s projected value at the end of the lease along with all the other lease terms. While residual value isn’t the only factor influencing the cost of your lease, it’s one of the big ones — and with an open-ended lease, the stakes may be higher.
Be sure that you understand the residual value and other costs associated with the lease before signing your lease contract. And consider residual value when you’re shopping around for the best lease terms for you.