As you consider your next car deal, you need to familiarize yourself not only with a growing number of options (buying, leasing or a subscription) but also with some terms you might not be familiar with.

“Residual value” is a term you’ll hear frequently if you’re looking at leasing a car. What does it mean and why is it important? Here's everything you need to know about residual value, including an example calculation. But first, it's helpful to get clear on what car leasing is.

A car lease is usually considered the “other” option to buying a car. That’s only partially true with the rise of car subscription services but leasing remains a popular choice with drivers across the U.S. When you lease a car, you pay an agreed monthly fee — usually for several years — and return the car at the end of the lease term.

You never own the car. It’s like a long-term rental that provides the freedom to change your car after several years. You can drive the car as if you own it but without the headaches of depreciation, high loan interest rates, and repairs (just like a FINN car subscription).

The residual value is the estimated value of the car at the end of the term of the lease. Just like with all vehicles, leased cars depreciate over time but not at the same rates. So, the leasing company likes to forecast this depreciation.

The residual value must be disclosed on any lease contract with a vehicle buyout option. A residual percentage is usually detailed, from which you can calculate the actual residual value (example provided below).

If we consider that the average car lease term in the US is 36 months, the average residual percentage for such leases is around 50 percent but you may see deals in the low 40s or up to 65 percent.

Unless you plan on buying the car at the lease end, it may not concern you greatly how much it’s depreciated after you finish driving it.

But the residual value (a measure of depreciation) is key to how the leasing company makes its money — and, as such, it should concern you before you sign your lease because it will affect your monthly payments.

Monthly lease payments are essentially calculated according to the depreciation of the value of the vehicle over the period of the lease — plus fees and interest. A higher residual value generally equates to higher monthly payments. Of course, the residual value of the vehicle is also of great interest to you if you’re planning to buy the car at the lease end, as some drivers do.

The residual value of a car changes every month and year. The leasing company or lending institution will use third-party analysis of the vehicle and marketplace to determine depreciation and arrive at a residual value that covers their risk. 

The analysis will include past vehicle models and consumer trends, which will affect the residual value of a car. It’s also affected by the car’s perceived reliability and safety record, as well as technological advances, gas price fluctuations and general economic conditions.

This calculation is made before you sign the lease agreement and may look something like this: 

• Manufacturer's suggested retail price (MSRP) of the vehicle: $40,000
• Residual percentage: 50%
• Residual value: $20,000 (50% of the MSRP)

Your monthly payments over the term of the lease (usually a minimum of 36 months) will depend on this residual value plus other factors and will be detailed in your contract.

When negotiating a car lease, there are many areas that the leasing company may have some wiggle room with. You may be able to negotiate a more manageable monthly fee.

The residual value is not one of these areas. It is fixed and you generally cannot negotiate it. The best strategy is to focus on factors you can negotiate, like the money factor or mileage allowance.

Even though you can’t negotiate residual value, it may still inform your choice of car. It makes sense to find car options that retain their value because lower depreciation means lower monthly payments. 

But, remember, if you plan to buy the car at the end of the lease, a higher residual value also means the buy price is higher. Make sure that the residual value is fairly set by choosing a reliable leasing company.

If you’re considering your options for your next car, consider Leasing vs Buying vs Subscribing.

There are two main types of car leases and the residual value affects them in different ways…

1. Closed-end leases

With a closed-end lease, at the lease end, you’re only responsible for the condition of the vehicle (i.e., any excessive wear and use).

So, if the car is worth less than the residual value at the lease end, you have no obligation other than to pay what you’ve promised to pay for excess mileage, etc.

2. Open-ended leases

With an open-ended lease, you are responsible for the vehicle's value (i.e., deficiencies between the realized value and the residual value).

So, if the car is worth less than its residual value at the lease end, you may be on the hook for the difference between the residual value and the fair market value of the car.

You can buy the car at the end of the lease with both options but the question of whether it’s wise to do that is the subject of another post.

The total costs of leasing a car include many factors but the residual value is a big-ticket item when calculating monthly payments. Understanding how the residual value affects these payments and how much you buy the car for at the lease end can help you hunt down the best deals. 

As you begin researching, one strategy is to focus on vehicles with the best residual value, as these hold their value well and may reduce monthly lease payments and the buy price at the end of the lease.

If you’d rather not worry about the residual value and are looking for more flexibility with the car(s) you drive, check out a FINN car subscription. 

With FINN, you can change your car as often as every 6–12 months and fast, reliable and flexible service takes care of everything from insurance to roadside assistance — all conveniently included in one monthly fee. Find your car today.