What is residual value?

Quick insights

• Residual value is a projection of what an asset will be worth at a certain point in the future.
• In the auto world, residual value projects how much a car will be worth later—at the end of a lease, for example.
• Because it’s an estimate, a car’s residual value doesn’t always match its market value when someone wants to sell their car or buy out a lease.

Residual value can have different implications in different industries. For a vehicle, residual value projects value over time based on depreciation and market trends. A decision to lease or buy a car can benefit from an understanding of residual value.

What is the residual value of a car?

A car’s residual value is a projection of what the car will be worth at a point in the future. The figure is expressed as either a dollar amount or a percentage. As a percentage, residual value would be based on the initial purchase price or Manufacturer’s Suggested Retail Price (MSRP).

The residual value of a car also depends on whether you’re talking about leases or sales:

• Leases: The residual value for a car lease would be the car’s estimated value when the lease term ends, such as two or three years. The figure will be used to calculate lease payments and a potential buyout price (the cost to buy the car at lease-end).
• Sales: A car’s residual value in sales is its expected resale value after a certain number of years. Although it’s a projection, residual value can indicate the future upside of selling or trading in a car that you want to buy right now.

How is a car’s residual value determined?

A combination of factors influences residual value, such as make, model, mileage, condition and market trends. However, it’s a dealership or leasing company that sets a car’s residual value based on its assessment of a range of factors below.

The vehicle details

• Make: Some manufacturers stake their reputations on vehicle longevity. This goes against the perception that all cars depreciate at the same rate.
• Model: Car models that retain strong demand in used car sales might have higher residual values.
• Features: Certain safety features and technology contribute to residual value because they’re generally desirable regardless of the make or model.
• Fuel efficiency: This is a selling point regardless of a vehicle’s make or model and very often affects its value.

Mileage, wear and use

• Mileage: This represents the amount a car has been used, so it’s linked to depreciation and impacts a car’s value at any given time. Lease agreements typically have mileage limits, as well. They can be used to determine the car’s residual value. This is why excess mileage fees might be charged—to compensate the dealer for unexpected depreciation.
• Physical condition: Like mileage, the state of a vehicle is a significant factor in determining its value. A lack of routine maintenance, modifications, plus damage and repairs usually hurt a car’s residual value. Plus, it often decreases as the time period increases because of expected use. For example, a car’s residual value at two years would likely be more than it would at three years.

Economic conditions

Several market trends can influence car values, from demand to fluctuations in gas prices. When fuel costs increase, for instance, vehicles with better fuel economy are thought to retain value. In addition, buyer trends can inflate a value, such as a surge in electric vehicles’ popularity. Basically, the exact time you buy a car affects its current value and, by extension, the residual value.

Can you negotiate a car’s residual value?

Residual value is typically non-negotiable when you buy or lease a car, similar to the acquisition or disposition fees. That said, a dealership or leasing company might adjust a car’s residual value to attract customers or close a deal. If you try to negotiate the residual value, you’d have to do it before finalizing the paperwork.

Residual value vs. lease buyout

These phrases, while related, aren’t directly comparable. A car’s residual value is an important figure in the context of a lease buyout or purchase option, which may be available when a lease term ends. You might have the option to purchase the vehicle at its residual value or some other price based on residual value. The details would be outlined in your lease agreement.

Should you buy a leased car for the residual value?

A car’s residual value is a notable reference point, but it’s not necessarily the best factor in a choice to buy. It depends on your financial situation, and the buyout terms in your lease agreement are important to understand.

Buying out a leased car for its residual value is probably appealing when the car’s market value is higher than the residual value. In a way, you could be getting a bargain. However, you may have to pay the difference between the car’s market value and the residual value.

In conclusion

In the auto world, residual value projects a car’s value and is important for both car leases and sales. Residual value calculations factor in the details about the car, such as make and model, as well as depreciation and market trends. However, dealerships and lessors determine residual value on their own terms.

A lease agreement may have an option to purchase the vehicle at lease-end for a residual value stated in the agreement. In terms of selling a car, however, residual value projects what a car may be sold for several years down the road. The actual value of a car at any point in time is based on several factors.