Residual value is a prediction of how much a good or asset will be worth once a leasing term is complete. In other words, it is a calculation of the future monetary value of something once the lease on it has ended and it has been returned to its owner, or when its owner is ready to sell or dispose of it. It can be applied to any leasing or loan situation, but it is most commonly applied when consumers lease vehicles.
If you’re shopping around for a car to lease, you may have come across the term “residual value”, or simply “residual,” when reading leasing documents or speaking to sales representatives. Although you may be more concerned with the reliability or fuel economy of the car you intend to lease, it’s important to pay attention to the number associated with this term in your contract.
A high residual value is usually an indicator of a good leasing agreement, whereas a low residual value might mean more monthly or upfront costs for you, the lessee.
What is residual value?
From an accounting perspective, residual value is just another name for “salvage value.” The salvage value of an asset is the remaining value of an asset after it has depreciated — or gradually lost value — to the point that it has reached the end of its useful life. Physical assets such as computers and other machines almost always depreciate due to degradation and being made obsolete by new technologies.
Not surprisingly, depreciation applies very well to cars. If you lease a vehicle for three years, it’s possible that a new model will have come out by the time the lease is over. Your use of the vehicle will also add wear to the vehicle’s internal and external components, bringing it closer to the end of its useful life.
When considering a leasing agreement, upfront costs, monthly costs, fees, and the overall health of the vehicle should all be factors you consider. However, keep the residual value of the vehicle in mind, as well.
How is residual value calculated?
The residual value of a good or asset is determined by the bank or financial institution issuing the lease. Many vehicle lessors also use the Automotive Lease Guide (ALG) as a reference when determining residual value. ALG is a private company that provides consulting and analytics services to automotive equipment manufacturers, lenders, fleet companies and other businesses in the automotive sector.
The residual value is always represented as a dollar figure, but it is calculated as a percentage of the vehicle manufacturer’s suggested retail price (MSRP).
For example, if a vehicle has an MSRP of $30,000 and its residual value is 50% after a three-year lease, then the residual value is $15,000. There are two ways this number might affect your leasing agreement.
First, if you already have a closed-end lease, you’ve already agreed to rates and a payment schedule. You can turn in your vehicle once the lease is over without worrying much about the residual value. Second, if you have an open-ended lease, you may be required to pay the difference between the residual value and the actual resale value of the car if it turns out to be worth less than expected.
What impacts residual value?
Residual value is typically only determined by the MSRP. It’s just a projection. There’s no way to assume what might happen to a vehicle or the auto market during the term of its lease, so only the expected depreciation of the vehicle can be used in the calculation.
There is a difference between residual value and resale value, however. The resale value is the amount the car can be sold for once the lease is over. For example, if a car has no useful value after the lease and is considered a “clunker,” it may have a resale value of as little as a few hundred dollars.
Factors that contribute to the resale value of a car include the exterior condition, interior condition, operational condition, mileage, economic factors (like demand) and obsolescence.
If you have a closed-end lease, you don’t typically have to worry much about resale value. If you have an open-end lease, however, you’ll need to make a payment for the difference between the residual value of the vehicle and its fair market, or resale value.
Residual value and lease buy-out
If you have an agreement to purchase your car after the lease is over, expect to pay the residual value at the end of your lease. While it may seem like a low residual value would be good in this situation, you also need to consider your monthly payments during the lease term.
A vehicle with a low residual value won’t cost you as much when you finally purchase it, but you could be stuck with higher monthly payments. Meanwhile, a vehicle with a high residual value might mean lower monthly payments but a higher final purchase price.
Here are four lenders to consider that offer lease buy-out loans:
Bank of America
Bank of America’s auto loan rates start at just 2.99% APR. However, the minimum amount it finances is $7,000. Bank of America offers auto loans to buy out an existing lease, so you can get the financing you need to own your car at the end of your lease with another provider.
U.S. Bank gives you some flexibility in that you can choose to purchase your vehicle while your lease is still active. It also allows you to change your due date once during the lifetime of the lease.
U.S. Bank charges an origination fee for loans. There may be other miscellaneous fees associated with leasing through this bank.
Lightstream’s auto lease buy-out option comes with a starting 4.99% APR. It’ll provide you with up to $100,000 to lease a vehicle.
Applicants with a good credit score can get a low-interest, fixed-rate loan from LightStream. LightStream may be able to provide funding as soon as the day you apply.
Auto Credit Express
Auto Credit Express is a sub-prime lender that works specifically with people who have bad or nonexistent credit scores. This is a good option if you need to lease a vehicle and can’t get financing elsewhere. It doesn’t disclose any of its rates, but you can expect to pay relatively high rates and monthly payments if you lease through it.
The bottom line
Consider the residual value when shopping for a leased vehicle as it could impact your monthly payments or the amount you pay when you buy out your lease. In most cases, a high residual value is an indication of a better deal, whether you intend to return your vehicle or purchase it.