What is the residual value of a car?
27 May 2021The residual value of a car is an important consideration for those who choose to lease their vehicle. Canstar explains what the term means and its potential impact on those in the market for a new car who are considering leasing as an option.
What is the residual value of a car?
When you’re leasing a car, the residual value is what the car is worth at the end of the lease term. It’s an important concept, because vehicles typically depreciate (go down) in value as they get older. So, after a few years, a car’s value may have decreased significantly compared to what it was worth when it was first driven out of the showroom.
A car’s value typically depreciates fastest in the first few years, with the rate of depreciation slowing as the car gets older. Cars tend to lose their value over time for a variety of reasons, including:
- Wear and tear on the car and its engine
- Where the manufacturer releases a newer version of the car’s model, the older model typically becomes less desirable
What could the residual value mean for a lease agreement?
Lenders know that cars they lease to consumers will devalue over time. For this reason, they will typically calculate the regular lease payments based at least partly on the loss in value that’s expected to occur to the vehicle during the lease term. However, other costs and factors are also likely to be built into the regular lease amount that’s charged.
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How much do you pay buying a car at the end of a lease term?
If you arrange to purchase the vehicle at the end of the lease term, the amount you would need to pay would typically also be based on the vehicle’s residual value. This amount paid at the end of a lease term to buy a car is often referred to as the ‘balloon payment’. A decision from the ATO in 2002 sets out the minimum residual values for leased cars (based on an effective life of eight years). As a formula, according to the ATO’s ruling, this is shown as:
Minimum residual value as a percentage of cost = 75% − [ (75% / Effective life ) × Term of the Lease ]
Residual value of a lease car
| Lease year | Minimum residual value |
|---|---|
| Year 1 | 65.63% |
| Year 2 | 56.25% |
| Year 3 | 46.88% |
| Year 4 | 37.5% |
| Year 5 | 28.13% |
Source: ATO.
In other words, after a one-year lease, the residual value of the vehicle would be at least 65.63% of its original value, etc.
What is a novated lease residual value?
If you enter into a novated lease for a car (an arrangement between you, the car seller/lender, and your employer where the lease payments are deducted from your pre-tax salary), the car’s residual value may also be a significant factor in determining the regular lease payments, and the final payment required to buy the vehicle outright, if you decide to purchase it at the end of the lease term. If you decide not to buy the car at the end of the lease term, you may be able to either trade it in and enter a new novated lease for a different car, or renew the lease based on the car’s residual value.
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This article was reviewed by our Sub Editor Tom Letts and Sub Editor Jacqueline Belesky before it was updated, as part of our fact-checking process.
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