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What are car residuals and how do they work?
by Canvas • November 20, 2018

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Residual value is a crucial component of car subscriptions. Still, many people don’t completely understand this concept. We’re sharing how car residuals work, why they are important, and more.

What is Car Residual Value?

The residual value is an estimate of how much your vehicle is worth at the end of its useful life (or subscription). Subscription companies base residual value on car depreciation — the difference between the value of your car when you first begin your subscription and when you finish it.

“You may have heard that a new car instantly drops in value when it is driven off the dealer’s lot. What you may not know is that depreciation tends to be much faster in the first 1–2 years of a new car, and slows down in subsequent years,” says tech writer Jason Gao. “Car subscription works by offering vehicles that have passed that initial fast depreciation stage, allowing consumers to pay a lower monthly payment on a car with no commitment.”

Once your subscription has ended, many car subscription companies will allow you to purchase your vehicle at its residual value. By this point, you will have familiarized yourself with your vehicle and its features, so you won’t have to spend time searching for a new car. Plus, your vehicle will cost less than if you were to purchase it brand new.

An Example of Car Residual Value

Still confused? Here’s an example of how car residuals work when it comes to vehicle subscriptions.

  • Say you take out a car subscription for three months. You choose a car that is worth $30,000, and you decide to travel across the United States.

  • After this three month period, your car will have depreciated in value.

  • Your car will now be worth **$20,000. **Your car will have lost $10,000 of its value.

  • Your car subscription company will spread the $10,000 across your weekly monthly payments.

Why is Residual Value Important?

Many people who opt for a car subscription are completely unaware that residual values will influence the amount they pay every week or month. The truth is, residual values are important. They determine whether you pay $500 a month or $1,000 a month for your car subscription, for example.

Residual values are more commonly associated with car leases, and the concept is very much the same. “Everyone focuses on low monthly payments and assume they’re getting a good deal,” says Real Car Tips. “What most people don’t realize is how residual values affect the price of your monthly lease payments. (Residual value refers to the value of the vehicle at the end of the lease).”

How Do Car Subscription Companies Determine Residual Value?

It can be difficult to calculate car depreciation and residual value. Different car subscription companies will use different calculations to estimate these amounts. Typically, car subscription companies consider the following factors when determining residual value:

Mileage: Car subscription companies will determine the average mileage of your vehicle model when calculating residual value. They may even apply a mileage limit to your car to prevent the vehicle from further depreciation.

**Vehicle Condition: **Car subscription companies use historical data to determine the condition of your vehicle when your subscription has finished.

As the above factors determine residual value, they will influence the price you pay for your car subscription every week or month. “Most use the Automotive Lease Guide (ALG) as a starting point. ALG publishes a Residual Percentage Guide that lists each vehicle’s predicted wholesale value after two, three, four, and five years,” says Real Car Tips. “The wholesale value is the price the car will typically sell at auction, which is how some leasing companies dispose of their vehicles after the lease ends.”

Car Residual Value Tips

Here are some car residual value tips that might want to keep in mind:

  • Some companies might inflate a car’s residual value, which means you will pay more for your weekly or monthly subscription payments. Therefore, you should choose a car subscription company that has lots of experience and a good reputation.

  • If you want to lower your car subscription payments, you might want to choose a vehicle that depreciates slowly.

Residual values might sound complicated, but it’s important to understand how they might influence the cost of your car subscription. Picking a vehicle that will slowly depreciate and choosing a reputable car subscription company will help save you money in the long run.

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