What to Know About Your Leased Car Equity

The term “equity” describes how much stake you have in a particular asset. If you have a $550,000 mortgage, but you’ve paid $250,000 of that so far, you have $250,000 of equity in your home. Equity doesn’t decrease the value of an asset but instead recognizes how much of a debt you’ve paid off thus far. 

Lease equity works a bit differently. Rather than building traditional equity like you would with a financed loan, you build equity in a car lease when the residual value is lower than the market value. However, any equity you have goes away when you return your lease. 

Leasing a car involves several complex financial terms, including depreciation, residual value, and equity. Each of these terms corresponds to a particular number that plays a larger role in how your lease works. The terms also affect how much it costs to lease a car. 

Residual value describes how much a leased car is worth after the lease term ends. Depreciation is the rate at which a particular asset (in this case, a car) decreases in value. Cars are mechanical devices that deteriorate and lose value as new cars arrive on dealership lots. 

Leasing companies determine a car’s residual value based on the depreciation rate over the lease term. For most leases, that’s anywhere from a year to three years at a time. You take a new car’s MSRP (manufacturer’s suggested retail price) and subtract the depreciation to get the residual value. This depreciation rate is pre-calculated at the time of signing your car lease based on current and forecasted market conditions. 

In some cases, the residual and market values of a car lease can be vastly different. If the difference favors the residual value, you will lose money if you purchase the vehicle at the end of your lease. However, if the opposite were true and you could purchase the car for less than the market price, you could use your equity in your favor. Thus, lease equity works in both ways. 

Leasing a car can give you equity, depending on the terms. The best car leasing deals happened pre-pandemic when the residual value of vehicles was forecasted to be low. With the inventory shortage necessary to fuel the automotive market, used car values skyrocketed. Your odds were even better if you drove thousands fewer miles than your lease accounted for. 

This change in market conditions gave many lessees an unexpected windfall. Most leases suddenly gained positive equity, where the leased vehicle’s market value was worth more than the residual value. Simply put, lessees could buy out their lease and either own a car for less than they’d pay without leasing or sell the vehicle for thousands of dollars in profit. 

Since the economic conditions during the pandemic have cooled slightly, many automotive manufacturers restrict lessee and third-party buyouts when a lease comes to term. You can no longer purchase your leased Tesla, and many other manufacturers have forbidden their leasing customers from working a deal with online retailers like Carvana and Vroom. 

It’s common to ask, “Should you lease and then buy a car?” but the real question is, “How much lease equity do you have to work with?” To find that answer, you must first understand where lease equity goes once your lease ends. Namely, that lease equity disappears once you hand back the keys.

Your lease equity fluctuates through your lease, primarily due to existing market conditions. You may have positive equity for one month and negative equity for the next. It all boils down to what your leased vehicle is worth and what residual value number appears on your lease. 

Consider a three-year lease on an Audi A5 Sportback with a residual value of $35,000. Should the market value of an A5 Sportback exceed $35,000 at any point during the lease, you experience positive equity. If the market value stays below that number, you experience negative equity. 

Savvy lessees know that when a leased vehicle is worth more than the residual value, buying out the lease and selling the car will profit them. It’s the classic “buy low, sell high” mentality. However, when you turn it back into the dealership, you lose any chance to make money on your lease. 

Instead of handing over the keys, you can bargain with the dealership to put your positive equity (if you have any) toward your next lease or finance deal. For example, if you were to drive your lease 10,000 miles less than expected at the end of the lease, that difference could result in positive lease equity that earns you $5,000 in capitalized cost reductions on your next lease agreement. 

Calculating car equity takes a bit of research and crunching numbers, but there are no complex mathematical equations. Instead, it’s a simple question of comparing numbers. Here’s a basic formula for finding equity in your leased car: 

Market value - residual value = equity (can be positive or negative) 

Locating the residual value of your vehicle is the easy part. Simply find that row on your lease agreement and write down the number. Next, you’ll need the market value of your car, which you can find on Kelley Blue Book’s My Car’s Value or Edmunds’ True Market Value. Just answer the prompts honestly, and you’ll come up with a range of values for your vehicle. 

Take a c, for example. If the market value is $50,000 and the residual value sits at $45,000, you’d have a positive equity of $5,000. However, if the market value was $45,000 and the residual value was $60,000, you’d have a negative equity of $15,000. 

The tricky part is that market values tend to fluctuate. The Grand Cherokee from the example above could have a market value of $50,000 one week and $35,000 the next. Many people consider getting out of a lease to make a profit but don’t consider the costs of early termination fees. It takes a keen eye to distinguish between risk and reward, though the reward can be tempting. 

In contrast to the 10 reasons not to lease a car, getting rid of negative equity can be an excellent reason to sign up for another lease. However, it depends on the circumstances and amount of your negative equity. Sometimes leasing to eliminate negative equity is the lesser of two evils. 

For instance, if you had $1,000 of negative equity in a loan but needed to get into another vehicle to cut your losses, that negative equity wouldn’t significantly affect your newly financed loan. It might also be better than losing three or four times that much and waiting months by selling your car private party. 

However, trading in a leased vehicle that has negative equity can put you at a severe disadvantage. This fact is especially true if you can’t afford your old lease payments and are looking for a new, more affordable lease. You’re still on the hook for the original negative equity, now in addition to the monthly payments associated with your new lease.

If all this talk of leasing has your head spinning, you’re not alone. There are multiple ways to get around, including the following: 

• Car-sharing: Sharing a car with others may seem like the short end of the stick, but it’s a great way to rent a car for a few hours or a day without committing to everything that comes with owning a car. Availability can be a challenge, especially in rural areas. 
• Long-term rental: Renting a car for months may not sound appealing, but it’s better than walking to most places. However, long-term rentals can quickly get expensive, and you may not be able to pick the car you want to drive. 
• Car subscription services: FINN offers a unique car subscription service that lets you pick the car you want and delivers it to your door. With FINN, you only have to worry about your monthly payment and fueling your vehicle to drive where you want to go.

Each option can be a welcome alternative to leasing, especially if you have negative equity. Check out FINN’s lineup of subscriptions to see which cars you can choose from. FINN offers flexible terms to fit your busy lifestyle.