Residual value on a car lease

Residual value refers to the estimated value of a car at the end of the lease period. This amount will likely be significantly less due to a car being a depreciating asset and losing value over time. Depreciation occurs due to wear and tear on the car and its engine over time, or when manufacturers release a new version of a car. Typically, a new car will depreciate faster in the first few years, after which the rate of depreciation will decrease with age. 

When you lease a car, the company offering you the lease understands that the car, unlike a house, will depreciate over time. To protect their financial investment, they’ll calculate the payments you make as part of your lease based on the depreciation your car is expected to have throughout the lease. As the residual value is the car's value at the end of the lease, it’s used to help calculate these repayments. 

Besides being a factor in determining how much you’ll pay for a car during the lease, the residual value also determines the price you could pay for the car at the end of the lease, if a purchase option is available.

You may want to calculate the residual value of a car you’re leasing to help you understand how your payments are calculated and if you can afford to buy the car at the end if this is an option. Understanding the residual value of the car you’re leasing helps you with your overall financial planning, repayments, and any future plans.

In 2002, the Australian Tax Office (ATO) set minimum Residual Values of leased cars (based on an effective life of eight years) as follows: 

Source:  ATO website

The Residual Value 'minimums' set by the ATO reflect the likely market value of a car at the end of the lease term. The ATO has also shared the formula for calculating the residual value of a leased item as follows:

Minimum residual value as a percentage of cost = 75% - [ (75% / Effective life ) x Term of the Lease ]

It’s worth noting that the calculations for the residual value of the car during the lease could vary from one lessor to another, despite the above industry standard set by the ATO.

The dealership where the car is coming from will not always be able to vary the terms of the value, but the financial institution offering the financing or lease does. If you think the minimum residual value of the car you’re leasing should be less than what’s mentioned in your agreement, you could try to negotiate a lower rate. Not all lessors will allow this, but it’s always worth trying.

If you are leasing a car to purchase it at the end of the term by paying off the residual value, you may also want to compare car loans to finance a car instead of leasing it. Both options have their pros and cons, and one may fit your requirements better than the other. Both leasing and financing will give you access to the car, but the terms and conditions will differ. It could help to learn the difference between leasing and financing a car to pick the most suitable option for your needs.

Some companies also offer car leasing as part of the perks package in addition to the salary. These leases are often called novated car leases.