The process of leasing a car can turn into a baffling journey through a maze of obscure terms and numbers.
Just for lack of understanding, many people leasing a car for the first time end up stuck in a contract where they’re paying much more than they wanted to. Fees, rates, values and unexplained percentages all add up.
When you’re going to negotiate a car lease, the more you know the terminology, the better a deal you can cut.
In this article, I want to explain one of the most important factors behind the monthly rate you pay on a lease car: residual value. I’ll clarify what it means, how it’s calculated, and – what really matters – how it affects your monthly lease payments.
What is residual value?
Residual value means the estimated price of the car at the end of the lease period. It’s also called lease-end value or lease-end buyout price.
Cars lose value from the moment they first roll out of the dealer’s lot. Mileage takes its toll and this year’s model makes old ones obsolete. So a car that was worth $25,000 new, in three years might sell for $15,000.
That gives it a residual value of $15,000, if you lease it for that period.
As a car leaser, what your payments have to cover is essentially the vehicle’s loss in value (depreciation) while you have it.
Looking again at that $25,000 car: if its residual value is $15,000, you’ll have to pay a total of $10,000 over the time you’re leasing it. (Plus taxes, fees and interest.) But if its residual value is only $10,000, you’ll have to cover $15,000 over those three years.
How residual value affects monthly lease payments
Residual value is one of the most important factors in determining your monthly payments on a car lease. The higher the residual value – meaning less of a difference between the car’s price now and its predicted value at the end of your lease term – the lower the monthly payments.
A low residual value means more of a difference that you will have to cover as the lease holder.
Residual value is shown as a dollar value but it’s calculated as a percentage of the car’s MSRP. (That’s the Manufacturer’s Suggested Retail Price, a guideline set by the manufacturers, not its actual selling price.)
Let’s say you see that our $25,000 car has a residual value of 60%. That will put it at $15,000 after three years. Divide that by 36 months and it will put your monthly payments (before taxes and fees) at just shy of $278 per month.
But if its residual value is only 40% (worth $10,000 after three years), your base monthly payment will be $15,000 divided by 36: almost $417 per month.
As you can see, it’s a big difference. According to Sergio Stiberman, CEO of LeaseTrader.com, a high residual value “gets you 80% of the way to a good deal.”
Who decides the residual value of a car?
Residual values, though they have a very real effect on your car payments, are actually just guesses, not absolute values.
They’re highly calculated guesses, based on factors like expected depreciation, past and current demand for that brand and model, expected effects of mileage, and predicted market conditions like the price of gasoline.
It’s typically set by the bank financing the lease, not the car dealer.
Most banks base their numbers on the annual Residual Percentage Guide published by the Automotive Lease Guide (ALG). This lists each vehicle’s predicted wholesale value after 2, 3, 4 and 5 years.
What lenders come up with depends on their own interpretation of available data, their risk tolerance and their leasing goals for the given vehicle. (More on this later.)
Automakers love high residual values. A high residual value can boost sales on a slow-selling model. If cars maintain their value well, lenders can offer lower payments that will make those models more popular.
It’s so important to them that the ALG presents competitive yearly awards to the cars with the highest residual values.
However, high residual values are a risk for lenders. If the car depreciates more than expected, they lose money on the lease contract.
Independent lenders have to strike a balance between offering enticing low payments to customers without exposing themselves too much to the uncertainty of market fluctuations.
To keep values high and boost sales, many leases are subsidized by manufacturers. In these cases, the residual values given by leasing companies will be a few percentage points higher than the quotes given by the ALG.
Should I look for a high or low residual value?
In general, car leasers should look for higher residual values. This will give you lower monthly payments. A high residual value will let you afford a much more expensive car. In fact, an expensive car that holds its value can be cheaper to lease than a lower-end car that loses a lot of value!
That said, it also depends on your plans with the car.
If you’re certain that you’ll give the car back at the end of the lease term, high residual value is the way to go.
But if you think you might buy the car at the end of the lease period, a low residual value might not be such a bad thing. After all, this is just what you will have to pay up at the end of the lease.
Of course, residual value isn’t the only important number. As a car leaser, you should also look out for a competitive interest rate and low fees, since these can really inflate your monthly payments.
Cars with the highest residual value in 2018
According to the Automotive Lease Guide, Subaru and Land Rover are the brands with the overall highest residual values.
Top passenger cars, in various categories, include:
- Kia Niro (Alternative Fuel)
- Subaru Impreza (Compact)
- Dodge Charger (Full-size)
- Honda Accord (Midsize)
- Genesis G80 (Premium Full-size)
- Audi All-road (Premium Midsize)
- Honda Fit (Subcompact)
The list of SUV’s includes:
- Subaru Forester (Compact Utility)
- Toyota Sequoia (Full-size Utility)
- Subaru Outback (Midsize Utility 2nd Row Seating)
- Toyota Highlander (Midsize Utility 3rd Row Seating)
- Jeep Wrangler (Off-Road Utility)
- Land Rover Discovery Sport (Premium Compact Utility)
- Land Rover Range Rover (Premium Full-size Utility)
For pickup trucks, the Toyota Tundra (full-size) and Toyota Tacoma (midsize) have the highest residual value. The Honda Odyssey tops the list for minivans.
Leasing a car is complicated business. If you don’t know what you’re getting into, you might find yourself paying much more than necessary.
Knowledge is half the battle. Once you know what some of the numbers mean, you’re in a much better position to find the best deal and even negotiate a better rate with the dealer.
A good car leasing company should work with you to decide on the best rate. After all, happy returning customers are the most valuable part of the business! At least, this is the attitude we hold here at Capital Motor Cars.
When you’re ready to check out the best deals on 2018 lease cars, contact us. We offer complete, transparent service to help you find the perfect vehicle at the lowest rate.