Residual value is defined as the remaining value of an asset after it has been depreciated, or simply put, the value of your car (as determined by the financing company) at the end of the lease term. In other words, it’s the difference between the MSRP when you leased the vehicle, minus things like wear and tear, mileage, and time. It also happens to be the cost of the vehicle if you decide to buy it at the end of your lease.
It’s typically represented as a fraction of the MSRP, such as 40% or 60%. For example, if the MSRP on the new BMW you leased was $40,000, a residual value of 60% would be $24,000. So if you negotiated the lease at the sticker price for the car with nothing down, you’d essentially pay $16,000 in deprecation costs throughout the lease term. If it’s a three-year lease, you’d be looking at a monthly payment of $444.44, plus interest, taxes, and fees. When all is said and done, your monthly payment would be in the neighborhood of $600.
The residual value of your leased vehicle is especially important in determining your monthly payments. A combination of a low net capitalized cost and a high residual will result in the lowest monthly payments, and thus, should be your goal in order to get the best deal.
Keep in mind that residual values vary greatly between among different vehicles. Luxury cars like BMWs tend to hold a good resale value, while newer makes and models are harder to judge, and typically get a lowball residual value because of that uncertainty. As a result, you’ll pay more for a new make because the residual value will have to be underestimated. Same goes for a car that isn’t in high demand, such as less popular American brands.
Let’s look at an example:
Ford Ranger XL
Residual Value: 30%
Lease Term: 36 months
BMW 328i Sedan
Residual Value: 60%
Lease Term: 36 months
In the above example, you’d be paying for 70% of the Ford Ranger over the first three years, or $12,495. For the BMW 3 series, you’d be paying 40%, or $13,690. As you can see, there’s not a huge difference between those two figures, thanks to the poor residual value of the Ranger and the excellent residual value on the BMW. As a result, the monthly payments between these vehicles would be fairly close. So in essence, you’d be getting more bang for your buck with the BMW, though the monthly payment would still exceed that of the Ranger’s.
Keep in mind however, that the BMW financing company may not give your new car a 60% residual value, and the Ford financing company may actually assign an inflated residual value to the Ranger to keep monthly payments down in an effort to sell more trucks.
The residual value can’t be negotiated, so it’s best to shop for a car that you know has a strong residual value, then negotiate the capitalized cost of the car to lower your monthly payments.