Residual value is the expected value of a car at the end of the lease term.
Learn how residual value is determined and how it impacts the cost of leasing a vehicle.
What Is Residual Value?
Residual value is the estimated value a vehicle will retain at the end of the lease period. It's one of the most important determining factors in the cost of a car lease, both to you and the lender.
How Residual Value Works
Say you've had it with public transit, biking, walking, or your current set of wheels, and have decided you need a new vehicle. You're not entirely committed to any one model enough to purchase it, and you decide that leasing a vehicle is a better fit for you. As you peruse different models and dealerships, the term “residual value” keeps popping up.
The residual value is projected by the lending institution holding the lease contract. They may reference Black Book or other industry resources, but every lender calculates residual value differently.
The lender will use the residual value as one of the main determining factors when calculating your monthly lease payment. They'll do the calculation as follows:
- You and the lender will first decide on the vehicle cost less any trade-in value or down payment.
- The lender will obtain your desired lease term and determine its residual value at the end of that term based on the agreed-upon cost.
- They will then determine the depreciation of the vehicle (starting cost minus residual value).
- They will then add the depreciation amount to any rent charges (which is similar to interest on a regular loan), taxes, and fees and divide that amount by the number of months in the lease term to calculate your monthly payment.
So, if you're leasing a $30,000 vehicle that is expected to depreciate by 20% over a one-year lease term, the residual value of the vehicle at the end of the lease period would be $24,000. You'll pay $6,000 total for the vehicle’s depreciation ($30,000 minus the residual value). That amount plus rent charges, taxes, and fees gets divided by 12 months, resulting in a $500 monthly payment before taxes and fees.
If you're looking for a vehicle that will retain a high residual value to lower your monthly payments, Kelley Blue Book produces an annual Best Resale Value Award guide. Ultimately, it will be the lender and not you who determines the residual value, but it’s a good idea to have a general sense of the vehicles with the highest and lowest residual values so that you can choose the best one for you.
How To Evaluate Residual Value When Leasing a Car
If you're looking to lease a vehicle for a set amount of time and then move on with your life, looking for a vehicle with a high residual value is a good idea. If a vehicle retains more of its value, the depreciation amount will be lower, so your monthly payments will often be lower.
Car manufacturers love to lease high residual value vehicles. The high resale price keeps the used-car market profitable, and the low monthly payments allow manufacturers to lease vehicles that haven’t been selling as well. Individual lenders love low residual values. They can lend a vehicle for a high monthly payment without having to worry about selling it at a high enough ending price to recover their investment.
That said, the residual value isn't the only factor to consider when leasing a car. The amount you are required to put down up front, the interest rate, and the taxes and fees are all important considerations. If you have a poor credit score, your interest rate will likely be higher, and it's even more important to shop around for the best interest rate if you fall into this category. A high interest rate or high fees associated with a poor credit score can add a significant amount to your monthly payment and the total cost of leasing a vehicle.
However, if you plan to purchase the vehicle at the end of the lease term, looking for a lower-residual-value vehicle is a smarter idea. Although you will pay more monthly during the lease term, the purchase cost at the end of the lease will be lower—just the residual value plus any purchase-option fees.
Keep in mind that discrepancies can occur between the residual value and its actual market value at the time when you're ready to buy it. This is because the lender may be incorrect in its estimation of the value of the car at the end of the lease term. In general, a lease buyout is worthwhile when the residual value is lower than the market value. Reconsider the buyout if the residual value is greater than the market value, as your car will be worth less than it would cost to buy the car.
It's also a good idea to compare the total cost of leasing and then buying at the end of the lease term versus just buying the vehicle from the beginning. You might find that you save money by purchasing the vehicle from the get-go (or vice versa).
Be cautious about working with "lease-here-pay-here" dealerships. These dealerships lease used vehicles and may have weekly payments and no coverage for repairs, so review the terms carefully before proceeding.
Residual Value vs. Salvage Value
Residual value is sometimes used interchangeably with salvage value. But residual value is more commonly used in the context of leasing to refer to the projected value of a car at the end of the lease term.
Salvage value is a more general accounting term that is regarded as the fair market value of property, or the value that would be recovered from the sale of the property at the end of its useful life when it's ready to be disposed of. In the context of vehicles, you can think of the salvage value as the amount that would be collected if an insurance company were to sell the vehicle to a salvage yard for its parts.
As such, the salvage value may be much lower than the residual value depending on the condition of the car at the end of the lease, which may be well before the end of the car's useful life.
Moreover, whereas a lender would estimate the residual value based on the cost and lease term, an insurance adjuster will estimate the salvage value based on the cost of vehicle disposal and previous auction values for similar salvaged cars.
|Residual Value||Salvage Value|
|Usually specific to leasing||More general accounting term|
|Expected value at the end of the lease term||Fair market value at the end of the property's useful life|
|Lender estimates it||Insurance adjuster estimates it|
|May be higher||May be lower|
- Residual value is the expected value of a car at the end of the lease term.
- Lenders estimate the value based on the agreed-upon cost of the car and the desired lease term.
- It's one of the most important factors that go into your monthly lease payment amount.
- Cars with high residual value are generally preferable when leasing as they're associated with lower monthly payments. When buying out a car lease, you want the residual value to be lower than the market value.
- Residual value differs slightly from salvage value, which is the value you'd get if an insurer sold a car at the end of its useful life to a salvage yard.