Leasing a car can be a great way to enjoy all of the new car benefits without having to deal with the high payments associated with new car ownership. At the end of the lease, you’ll have the option to buy the vehicle to own it outright. The amount owing will be determined by a number of factors, including the residual value.
Before you meet with a car dealer, it is vital that you arm yourself with a good knowledge of the basic details of leasing. Understanding the industry and business terms will put you in a better position for strong negotiations. One of the expressions you’ll hear quite frequently while discussing a car lease is “residual value”.
Residual value involves more than your monthly payments, and the buyout amount at the end of your lease. Leasing companies also use the vehicle’s residual value to establish any penalties owing should you break your lease early. It is an important word and you need to know precisely what it means, and how to estimate it.
The word “residual value” refers to the monetary value of an item after it has been used. In vehicle leasing, residual value is the depreciation of the vehicle’s value over the life of its lease. So, how precisely does the residual value affect your monthly payment?
When you lease a car, you are disbursing for the car’s initial value, spread over a period of time or the leasing term. For instance, suppose that you lease an $18,000 car with a two-year lease term. The leasing company needs to approximate what the value of this car will be in two years time, in order to determine how much of the car you will actually use during your lease term. This is where the “residual value” plays a vital role in the equation. If the residual value of the car is estimated to be $13,000 at the end of your two-year lease, then your monthly payments will be computed on the $5,000 you will use over 24 months. The average monthly payment, in this example, will be $208.30 ($5000 / 24 months) plus tax, interest, and fees.
On the other hand, if your car is expected to lose half its value over the same period, your monthly payments will be higher. In this scenario, you will be using $9,000 of the car’s value over the same two-year period, leaving you with a monthly payment of $375 plus tax, interest and fees.
As you can see, residual value is a primary factor in determining how much money you will pay over the course of your lease. A higher residual value connotes lower monthly payments. This formula can work against you if you decide to “buy out” or purchase your car at the end of the leasing term. Using the previous example, the lower monthly payments in the second scenario will end in a substantially higher buyout price at the end of the lease.
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To know which formula is perfect for you (lower vs. higher monthly lease payments), you should first determine whether you would be taking the buyout at the end of the lease. If you don’t want to make a huge down payment, and would desire to make lower monthly payments, then a car that holds a higher residual value is a good deal. If you are considering a lease-end purchase to own the car outright, then you need to balance low monthly settlements with a moderate residual value.
Leasing a vehicle is a big investment, and it takes some preparation and homework to ensure it’s an easy ride.
Filed under: Buy A Car