Residual Value – Why It’s Important

residual-valueAll new and used vehicles have a residual value.

It’s the estimated wholesale resale value (think trade-in value) that a vehicle will have after, say, 3 years. It’s important whether a car is being leased or purchased.

We know that all motor vehicles depreciate in value as they are driven and become older. So, residual value is what’s left after depreciation takes its toll. But all vehicles do not depreciate at the same rate. Some specific makes and models’ values drop faster and by larger amounts than other makes and models — which reduces their residual value.

Important when Leasing a Car

Residual value is especially important when leasing a car, although it’s also important when a car is purchased, as well explain in a moment.

When a car is leased, the monthly payment depends on the difference between the lease price and the residual value. Any car that has a high “residual” (retains its value well) will have a lower monthly payment than a similarly priced car that has a lower residual. Therefore, in leasing, it’s important to choose a car make and model that is expected to have a high residual value. (The LeaseGuide Lease Kit contains a residual calculator for all vehicle makes and models)

But, how does anyone know what a vehicle’s value will be in 3 years, or 4 years, or 5 years? The answer is: Nobody knows for sure but automotive industry market experts can predict residuals, from experience and past history, within a small margin of accuracy.  They know, for example, that an average vehicle will lose about 50% of  its original MSRP value in 36 months. Its residual value is therefore 50% of MSRP (the other 50% that remains after depreciation). So, an average $30,000 car will have an estimated worth of $15,000 after 3 years.

Residual value actually has two roles in leasing. First, it is an important factor in determining monthly payments, as we have already mentioned. Second, the residual value becomes the guaranateed lease-end purchase price in a lease contract. It’s the price at which the customer can purchase the car at the end of his lease, as an alternative to returning his car to the lease company. Since a particular vehicle never depreciates in exactly the amount predicted at the beginning of the lease, the purchase price can be lower than the vehicle’s current market value (good deal), or higher (not so good deal).

Important When Buying a Car

Why is residual value important when buying, not leasing?

It’s important because it determines a vehicle’s future trade-in or sales value. If a new car that originally cost $30,000 is worth 50% of MSRP after 3 years, it’s worth $15,000. Another $30,000 car of another make and model might only be worth 40% of MSRP after 3 years, or $12,000. Even though the cars originally cost the same, the owner of the first car has a $3000 more valuable vehicle to use as a trade-in, or to sell. So it makes a lot of sense to buy vehicles that hold their value well, i.e. have high estimated residual values. Again, the LeaseGuide Lease Kit contains a section that provides average residual values for all vehicle makes and models — which is clearly useful even when buying, not leasing.

Another time when residual value is important is if a car is stolen or totaled in an accident. Insurance companies pay current market “replacement” value for such a loss.  A car whose value depreciates rapidly will have a smaller insurance payoff than a similar car with a lower rate of depreciation.

Residuals are not normally considered when buying a used car. This is because a used car’s future value depends on many factors and is extremely difficult to predict. It’s safe to assume however that a car that has a high residual value when brand new will also hold its value well as a used car.

What Vehicle Makes and Models Have the Best Residuals

Generally, the vehicles with the highest residuals are those that are popular, that are very reliable, and that are expected to maintain their appeal for the near future. There can be great variations between vehicles in the same price range. For example, the Chrysler 200 has a low expected 3-year residual of 42% while a similarly priced Ford Fusion’s residual is much higher at 53%.  A $97,000 Mercedes S350 has a 43% residual, while a $97,000 Porsche 911 has a much better 59%.

Honda and Toyota generally have higher residuals than Ford and Chevrolet. Volkswagen, BMW, and Porsche’s residuals are typically better than Chrysler, Infiniti, and Mercedes. Lexus and Acura are higher than Audi and Cadillac.

Summary

Residual value is important regardless of whether you are buying or leasing a new car. When leasing, a high residual value reduces monthly payment amount and total cost. When buying, it increases future trade-in and resale value, as well as overall cost. Find current average residual values for any vehicle make and model in the Lease Kit.

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