What Is Residual Value?

• The estimated residual value is the worth of a vehicle at a certain point in its life, factoring in depreciation and other variables. The residual value affects your car buying or leasing decisions. 
• In leasing, the residual value is used by lessors to determine monthly lease payments and influence lease buyout options.
• A FINN car subscription offers an alternative to traditional ownership or lease deal, with a single monthly payment covering insurance, maintenance, roadside assistance, and depreciation.

A vehicle's residual value describes its estimated worth at a fixed point in time of its useful life. Physical assets tend to depreciate in basic economics, meaning their values drop over time. The rate of decline in value corresponds with the expected lifespan of that fixed asset, in addition to several other factors. 

Residual value is a term most often used in leasing a vehicle, as it helps determine the lessee’s monthly lease payments during the lease period based on depreciation. As a car depreciates, the residual value represents what value remains based on the Manufacturer’s Suggested Retail Price (MSRP). If you were to buy out your car lease, the final cost would consist of the residual value plus any applicable fees (taxes, titling, registration, etc.). 

Residual value vs. resale value 

Unlike resale value, an asset’s residual value within a lease doesn’t change. When drawing up the lease, the leasing company determines the residual value of the car and sets it in stone when signing the paperwork. However, resale value is closely related to residual value. 

A vehicle's resale value represents how much that particular car can be sold for on the market. Resale values directly correspond to the MSRP, incorporating depreciation, use, mileage, and upkeep. A vehicle’s resale value can fluctuate drastically depending on market conditions based on supply and demand. Regarding classics and rare exotics, resale values can even surpass the MSRP, propelling the car to appreciate rather than depreciate. 

Residual value vs. lease buyout

Lease agreements with the option to buy out the lease can help lessees take advantage of the equity they’ve built up in the car with monthly payments. Residual values and lease buyouts are closely related because the residual value determines the lease buyout price. Buying out the lease requires paying the residual value plus any additional fees that may apply. 

It’s essential to pay close attention to the residual value, especially when a lease buyout option is available. If the lease buyout price totals less than the market value of your particular vehicle, you’re saving money on the purchase price. However, high residual values can also drive up the price past what that car would sell for if you purchased it outside of the lease. 

You won’t be able to determine a car’s residual value by knowing how to check the warranty on your vehicle or figuring out how to increase your credit score to lease a car. Instead, look to the following factors to help you determine the residual value of practically any vehicle. 

Resale value

In relation to residual value, resale value can often be conceptualized as the star rating of a product or service that represents how customers receive it. For instance, five-star products tend to have a higher resale value (given they’re in good shape) than one-star products. If a vehicle has a higher resale value, the residual value also tends to be higher.  

Reliability

High residual values reflect reliable vehicles. In contrast, lower reliability ratings on a vehicle tend to result in a drastic drop in residual value compared to a vehicle’s MSRP. New cars tend to have a higher reliability rating than older vehicles, but buyers feel the effects of depreciation most in the first few years of a car’s life. 

Market conditions

One of the best ways to understand how market conditions affect residual value requires looking back at the automotive market during the height of the pandemic. When the shortage of vehicles drove up used car prices, market conditions didn’t follow what leasing companies had projected when drawing up lease agreements a few years before. In fact, the conditions favored lease buyouts because lessees could purchase their vehicles for (in some cases, significantly) less than market values at the time. 

Residual values represent a percentage of the MSRP, as expressed in the formula below: 

MSRP X Percentage of Remaining Value = Residual Value

For example, to calculate a 50% residual value of a Volvo S60 with an MSRP of roughly $52,000, the result would be $26,000: 

$52,000 (MSRP) X 50% (Remaining Value) = $26,000 (Residual Value)

Alternatively, you can manipulate the equation to calculate the percentage of the remaining value if you know the residual value: 

Residual Value / MSRP = Percentage of Remaining Value

In the same example, the residual value ($26,000) divided by the MSRP ($52,000) results in 0.5, or 50%. If the residual value were instead $20,800, the result would be 40% of the remaining value.  

Residual values can be beneficial in several aspects, including the following: 

• Determining lease rates: In negotiating monthly payments on a lease, knowing the residual value as part of a lease agreement can help you better understand the terms before you. Residual values are inversely related to payments, meaning a higher residual value can help you get a lower monthly payment.
• Calculating depreciation: Determining the residual value of an asset can also shed light on depreciation as it relates to the asset’s ability to retain worth. For example, all new cars depreciate in some form or fashion, but some do so faster than others. Those assets that depreciate more quickly tend to have lower residual values. 
• Evaluating a lease buyout: As previously mentioned, lease buyout options can help you get behind the wheel of a car you’re familiar with for less. However, determining the profitability of buying out your lease does require knowing more about the residual value first.

Residual value plays a vital role in any situation where a physical asset is present. In the case of a vehicle, residual value can help inform your purchase decision. 

Higher residual values often reflect an asset’s ability to retain desirability in current market conditions. A residual value between 55% and 65% (or more) of the MSRP represents a respectable residual value. However, this remaining value doesn’t exist in a vacuum; instead, consider it in the context of the automotive market to gauge the true value of that particular asset. Even if the residual value falls in the range above, the market may not support that pricing.