Jan 022012

Is the Highest Residual Value Lease the Better Option?

Residual Value Lease OptionsIs it better to get the highest residual value lease? Before we answer that question, it is important to know what residual values actually mean. The lease residual value is not always fixed when your car lease deal is calculated. In fact, the residual value is the one variable component of a lease that can most substantially affect the size of your monthly lease payment. Every year a financial company called, ALG or Black Book, publishes the residual values of all of available cars the cars on the market. This residual value is nothing more than an estimate of a car’s expected resale value as a percentage of MSRP. While these published residual values serve as a guideline for calculating lease payments, the actual leasing company can adjust this number up or down, depending on how aggressive or conservative they are about leasing a particular car. A leasing company might be willing to take a little extra risk on the value of a car late in the year where sales are exceeding expectations. In short, the published, 36, 48 and 60 month residual values of cars don’t always reflect the actual resale price. Cars that become extremely popular will often sell on the used market for a price that is much higher than their residual values. When a residual value is set too high, the leasing company absorbs the loss at the end of the lease term. A residual value that is set too low will yield an unattractive lease payment and be less attractive to potential car lessees. So, how does setting of the residual value end up affecting us when we lease cars? Because a higher residual value lowers our monthly car payment, it would seem that the higher the residual value the better. Not so fast:


Possible Downside of Highest Residual Value Lease

The only downside to a car lease with a higher-than-average residual value is that there is not likely to be any equity in your vehicle at the end of the lease. This is not a problem if you plan on driving your car for the full term of the leasing and turning it back in to the lease company. You can simply walk away without any additional costs and the bank absorbs the loss on a car that is worth less than what they sold it to you for. With a lower residual value, however, your car’s lease payoff might be lower than the actual value of the car, leaving you with some actual equity to apply towards a new purchase or trade in. A lower residual value also makes it much easier to turn the car in early or negotiate a trade with a dealer before your car lease term has expired. Of course, the trade-off is that you made higher car lease payments than you would have with a higher residual value. When car makers publish their lease offers every month, their incentives are often based on cars with higher than expected residual values. The leasing company is often owned by the car company. Toyota Leasing, Infiniti Leasing, Honda Leasing, Subaru Leasing, etc., are banking on higher than expected resale values of these cars that they promote in their special lease offers and incentives every month. So, unless you really want to play it safe and have some wiggle room at the end of your lease, a higher residual value is almost always better because it gives you a lower payment and preserves monthly cash flow which is the very purpose of leasing. To illustrate the trade off between a lower residual value vs. a higher residual value, see the example below:

Honda Accord LXALG Actual Residual%Promotional Residual%
MSRP$23,950 47%$23,950 65%
Sales Price (Capitalized Cost)$22,500 $22,500
Money Factor (Interest Rate).005 (1.2%).005 (1.2%)
Lease Payment$377.00$255.00
Total Cost of Lease Payments$13,572.00$9,180.00
Residual Value$11,256.50$15,567.00
Actual Car Value$15,567.00$15,567.00
Equity at end of Lease$4,310.50$0.00
Net Cost of Lease$9,261.50$9,180.00

As you can see, the highest residual value allows us to save $122.00 a month on our lease payment. Over the course of the 36 month term that is a savings of $4,392.00 over the lowest residual value lease. However, the lower residual value lease means that we will have a car that is speculated to be worth about $4300 more at the end of its lease term. While the difference may seem insignificant, three years is a long time to trust the speculation of resale values and the banks with your extra money. Unless, you were absolutely certain you wanted to get out of the car lease a few months early, the highest residual value is the way to go. While having a higher residual value might greatly limit your options at the end of the lease term, it also spares you an extra $122.00 in cash flow per month. There is another reason, however, that you might prefer the lowest residual value lease: If you plan on going over your monthly limit of 10,000 or 12,000 miles, the equity in your lease trade-in will provide you with some cushion at the end of your 36 month term. One who is very cautious and looks ahead may feel more secure about leasing a car with a more conservative residual value. It is similar to paying taxes. We can pay as much taxes as we can now, knowing that we’re saving up for a no-interest refund at the end of the year, or we can take every dime we get each pay check and get nothing back in return. The highest residual value lease possible is the best car leasing option for most of us. It is also the reason we see some unusually good car lease deals on the pages of monthly car lease each and every month.

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