The residual value of a leased vehicle is the lessor's estimate of what the vehicle will be worth at the end of your lease term. Sometimes referred to as the lease-end value, the residual value is an important number to know for a couple of reasons. Your monthly lease payment is based on the difference between the adjusted capitalized cost and the residual value of the vehicle (we will discuss this fully in Chapter Three - Assembling the Pieces). For that reason, knowing your residual value is essential in determining your repayment liability.  In addition, the residual value represents the minimum you should expect to pay if you elect to exercise your purchase option at lease end (in a closed end lease). In an open-end lease, the residual value takes on even greater importance. 

The Basics

Residual values are usually figured as a percentage of the vehicle’s MSRP. For example, a $25,000 MSRP and a 50% residual factor will result in an estimated $12,500 residual value at lease end. You can get a pretty good idea of what the industry thinks the residual value of your vehicle should be by consulting the industry-standard Automotive Lease Guide.  The ALG residual value on a vehicle represents what a reconditioned clean vehicle should fetch at auction. That’s right, it’s wholesale, not retail.  ALG values typically represent the conservative end of the spectrum. 

At the other end of the residual rainbow usually reside captive finance companies, which inflate projected residuals in order to deliver lease incentives akin to rebates on vehicle  purchases.

The Market

Residual values will vary depending upon the particular model you choose, the lessor (i.e. bank, captive finance company or independent leasing company), the amount of miles you  anticipate driving, and particular promotions being offered on that model.  In all cases, the lessor -- not the dealer -- sets the residual value (although some dealers have been known to shave the residual to earn more money on the deal). So, the best you can do is shop among different lessors for the most competitive number. You can expect variations among values offered by the captive finance companies, independent leasing companies, and banks.  When shopping residuals, be sure to research similar type vehicles made by different manufacturers to take advantage of unusually high residual values being offered to aggressively promote certain models.   

The Math

Those looking to enter into a closed end lease (most consumers), should shop for the highest residual value possible because the higher the residual value, the lower the monthly  payment will be, all other things being equal. This occurs because the residual value is subtracted from the adjusted cap cost to arrive at the amount you must repay over the lease term. 

Low Residual:

   18,000                   -      9,000      =        $9,000 (amount to repay)
Adj. Cap. Cost                   Residual

Higher Residual:

   18,000                   -      10,000     =      $8,000 (amount to repay)
Adj. Cap. Cost                     Residual
 

High-Low Game

Believe it or not, there are times when you might not wish to have a high residual value.  If you are planning to enter into an open-end lease, for example, you will be safer with a  less aggressive residual value.  In an open-end lease, you are liable for the difference between the predicted residual value and the actual amount received by the lessor on the sale or auction of your vehicle  at lease end. If the open-end residual value is artificially inflated to reduce the monthly payments, the shark will show up at lease end when the actual market value of the vehicle is lower and you owe the  difference. (Under Regulation M, this amount will usually not exceed the sum of 3 monthly payments.  If you are seriously considering a lease-end purchase, you may also be a candidate for a lower residual value  because that is typically the amount you will be expected to pay for the vehicle. Of course, you must balance that possible saving against higher monthly payments.   A low residual value also makes good sense if you are leasing a vehicle for business purposes and you have the opportunity to purchase it for personal use at lease end.  Provided the vehicle is actually being used for business, the higher monthly payments may be deducted as a business expense during the course of the lease, leaving a reasonable purchase option amount for you at lease end.  Unless you fit into one of those categories, however, you will likely find yourself shopping for a high residual value in order to obtain the lowest monthly payment. Manufacturers are aware of this and often "push" the residual value in order to advertise and deliver lower monthly payments. This usually operates to your benefit.

TIP: High residual values offered by captive finance companies are often accompanied by low money factors.  Shop, look and listen for this compelling combination!