Depreciation vs Residual Value
By Jakob Hansen, 2/10/2020
Leasing is a complicated game of give and take, let’s get to the bottom of what the key terms actually mean.
When leasing, there are many important terms that get tossed around, but two of the most important terms are depreciation and residual value. What exactly do these terms mean and how do they affect you?
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Leasing is like finance purchasing in many ways. You still get to choose the trim level and options you want. You still make a down payment and monthly payments. But they’re usually lower than a down payment and finance payments for the same car. That’s because you pay for only part of the car’s value, and the person who drives the car after your lease pays for part of it. The dealer or automaker’s finance arm, usually, retains ownership and ownership responsibilities. You lease for a predetermined period of time with a predetermined mileage allowance.
Leases are usually for shorter periods of time than auto loans. Leases last 12 months to 60 months; 36- and 39-month leases are popular because they’re a good balance between depreciation and obligation. While a loan can be any length, many are twice as long as the average lease. Sixty-two percent of new car loans are for more than five years. With a lease, the longer you lease the more you save. With a loan, the shorter you finance the more you save--but the monthly loan payment amount will double, triple, or quadruple. Not so with a lease.
Advantages of Leasing
Lower payments are a primary advantage of leasing. Leasing drivers get to choose whether to move up in car or pocket the savings. They get to move up to a new car every few years. They get to choose terms that match their usage and choose what kind of protection they want for catastrophic circumstances and excess wear. All but the longest leases are covered by warranty, another advantage over ownership. And leasing is simple, both at the beginning and at the end, when you get to choose again: whether to buy the leased auto and keep driving it, buy it and sell it for profit, return it and walk away, or return it and lease again.
Depreciation and Residual Value
Leasing is founded on the concept of depreciation and residual values. Cars lose value over time, it’s a fact. Mileage affects this loss of value, or depreciation, and so does expected reliability or longevity. If a car’s effective life is 15 years, it will depreciate more slowly than a car whose effective life is 10 years. If it’s driven 20,000 miles a year, it will depreciate more quickly than if it were driven 10,000 miles a year.
Independent auto valuation agencies publish data that translate depreciation into estimated resale values according to age, mileage, and options. Your leasing agent will use that data to establish your Cadillac Escalade lease “residual value.” This figure determines your monthly depreciation payments: Subtract residual value from MSRP or negotiated leasing price to get estimated depreciation over the whole lease. Add lease options, if applicable, then divide by the number of months in the lease. The result is your monthly payment amount.
The residual value is also your guaranteed sale price at the end of the Cadillac Escalade lease. You don’t have to buy, of course. But if you love it, buy it. Or, if actual resale prices for used Escalades like yours have risen, then buy it for the binding residual price and resell it for profit.
Resale values are generally strong for Escalades, so they’re good leasing choices. But from one Escalade to another, resale value can vary. For instance, an Escalade equipped with certain optional safety enhancement options will usually have more value than same-year Escalades that lack the optional features. Sometimes one option will spike resale value. Study the estimated resale values for Escalades with and without various options. Those whose estimated resale values represent the highest percentage of their original MSRP are the lease value winners.
Early Termination and Lease End
When your Cadillac Escalade lease is several months from maturity, look up current transaction prices for used Escalades and see how they compare against your Escalade lease residual value. Also have your Escalade inspected. Crunch the numbers. Can you profit from buying and selling? Will buying save wear and overage fees? Will you lease another Cadillac or call a cab?
Lease Pull Ahead waives a few months’ payments for those who want to upgrade a little bit early. If you break the lease midway through the term, though, early termination fees stated in the lease agreement will apply. Protect the investment by sticking out to the end. You’ll qualify for waiver of an industry-standard “lease disposition fee” and for loyalty incentives.
Jakob is our writer with a love for all things automotive. He comes from a dealer background with experience on both sides of the fence. Knowing the system inside and out, he knows the best cars and the best deals. No matter what.