If you have a leased car (or are thinking about leasing), you have probably seen the term residual value a few times. But what exactly is residual value, and what does it mean for you?
Let’s talk about how car leases work and what residual value is.
How do car leases work?
Leasing a car is essentially renting a car. The dealership owns the car and holds the title, but they give you temporary ownership for a set period of time. While you have the car you are responsible for maintaining it and not overusing it (a mileage allowance will ensure this). Leases are usually 24-36 months, but they can be longer.
While many people in the United States prefer buying cars, more than a few prefer leasing a car instead. In 2022, about one in four cars on the road in the US are leased. So why exactly would some people prefer leasing over buying?
Your monthly payments will be lower
When you lease a car, your payments will be much lower than if you were to finance it. This is because you are really making payments on the depreciation that will occur while you are leasing the car, not on the total amount of the car.
You need less money up front
Not only will your monthly payments be lower, but when you lease a car you will need less money up front. In many cases you can lease a car with no money down. Any fees that you are required to pay can usually be rolled into your monthly payments.
You will not need to sell your car afterwards
When you lease a car, you can simply hand the keys back at the end of your lease period. You do not need to worry about selling the car when you are finished.
You can get a new car every couple of years
Some people love having the latest and the greatest, and leasing can allow you to get a new car every few years. This makes it easier to stay up to date with the latest technology (and who doesn’t love the smell of a new car?)
You can maximize tax deductions
If you are a business owner or are self employed, leasing a car will provide more tax advantages than buying a car. When you lease you can write off both the depreciation costs and the financing costs, which is usually more than you can write off when you purchase a car.
What is Residual Value?
There are a lot of terms that you should be familiar with when you decide to lease a car. Lease payments are calculated as follows:
Capitalized Cost - Capitalized Cost Reductions - Residual Value + Interest + Fees
Let’s take a look at what these terms mean.
Capitalized Cost
This is the actual price of the car which will serve as the basis for all of your lease payment calculations. This price can be negotiated, just as you would negotiate if you were buying the car outright.
Capitalized Cost Reductions
Capitalized cost reductions are any discounts that the dealership may apply to your lease. This includes any rebates, incentives, and upfront capital that you may put into your leased vehicle.
Residual Value
The residual value of a leased car is the expected value at the end of the lease term.
Money Factor
The money factor is the financing charge of the lease. This number is a small decimal that might feel foreign to most people, so multiplying it by 2400 can give you an equivalent APR.
How is Residual Value Calculated?
One of the most important factors in your lease is the residual value of the car. The residual value of your leased car is based on three factors:
- The capitalized cost
- The lease term
- The residual lease value percentage
The capitalized cost of the car is simply the sale price of the car. Your lease term will depend on what you select, but it is typically 24-36 months. The residual lease value percentage is somewhat subjective. It is what the car is expected to depreciate over the life of the lease.
If you have a leased car with a capitalized cost of $30,000, and the car is expected to decrease in value by 50% over your three year lease, then the residual value of your car is $15,000. The residual value of your lease is important for two main reasons:
- It will determine what the monthly payments on your leased car will be
- It will determine what the buyout price of your car will be at the end of the lease term
Unfortunately you are usually not able to negotiate the residual value of your car. It is typically a standard price based on what the dealer believes the resale will entail. But you can negotiate on the capitalized cost of your lease.
Should I Buy My Leased Car?
When your lease ends, you might be wondering what options you have. You ultimately have three choices when your lease ends.
You can keep leasing
If you like leasing, you may simply want to continue leasing a car. You can simply return your current car and resign for a new lease with a new car. This is the simplest option for most people and iit is also the best option for most dealerships. When you keep leasing, you will restart (and negotiate) with a new car, and the dealer can sell your old lease as a certified pre-owned car. In order to return your car with no fees or issues, you will need to return your leased car in good condition and without going over your mileage allowance. If there is significant wear and tear, noticeable damages, or you have gone over your mileage allotment, this could mean you owe the dealership money.
You can end your lease and walk away
If you aren’t happy with leasing, you can also choose to turn in your lease and not lease again. Again, in order to return your car with no fees or issues, you will need to return your leased car in good condition and without going over your mileage allowance. If there is significant wear and tear, noticeable damages, or you have gone over your mileage allotment, this could mean you owe the dealership money.
You can buy your lease out
But maybe you don’t want to say goodbye to your car. Or maybe you know that you have racked up a lot of miles (way over your allotment) and you are going to owe some serious fees. Or maybe you know that there is quite a bit of wear and tear and you will similarly face some big fees. Whatever your reason is, a lease buyout is often a great solution at the end of your lease.
How to decide which is best for you
If you are trying to decide what is the best option for you at the end of lease, there are some questions you can ask yourself to help decide.
To decide if you want to keep leasing, ask yourself the following:
- Do I like leasing?
- Have I been able to stay under the mileage allowance?
- Have I been able to avoid major wear and tear?
- Do I like having a new car?
- Am I ok not being able to customize the car to make it my own?
If you answer yes to most of the above questions, then leasing again might be a good move.
To decide if giving up your lease and moving on is a good idea, ask yourself the following questions:
- Do I dislike leasing?
- Is it hard staying in the confines of the lease agreement?
- Am I indifferent when it comes to having a new car?
- Do I have another way of getting around (a different car or a public mode of transportation?)
If you answer yes to most of these questions, then returning your lease and moving on might be a good idea for you.
But for many people, a lease buyout will be their best option. This is because today’s used car market has a lot of demand. That means your car’s resale value is almost guaranteed to be much higher than your residual value. In other words, you will be able to buy your lease for much less than you will be able to sell it for. Ask yourself the following questions to decide if a lease buyout is right for you.
- Do I like my car and want to keep it?
- Do I want to sell my car privately and make a profit?
- Have I gone over my mileage allowance that will result in major fees?
- Do I have significant wear and tear that will result in major fees?
If the answer is yes to any of the above questions, a lease buyout is probably the best option for you. And a lease buyout loan is an easy way to achieve this.
That's how car leases work and how you can decide if buying out your car lease is a good idea.
Auto Approve specializes in car lease buyout loans and can help you decide if a lease buyout is right for you. Contact Auto Approve today to chat with one of our agents today!
