Understanding depreciation, residual value in a lease

By Christopher Cruise Bankrate.com

Depreciation. Residual value. Same concept, different perspective. It's like considering whether the glass is half full or half empty.

But one thing's for sure: If you're considering buying a new car or leasing, it's critical that you "get it."

Depreciation is the negative way of looking at it -- how much value is lost in a given period. Residual value is a more positive perspective -- how much value is retained.

We all know the value of a new car drops as soon as you drive it off the lot, but how much it drops and continues to fall as the miles and the years go by has been a guessing game for most consumers.

No longer. Various organizations have set up sophisticated tracking and database systems to gather and analyze data from sales, resales, trade-ins and leases to help you make comparisons between different leases easily and accurately.

The result? The coar-shopping site Edmunds.com says the cars that hold their value best are also among the most expensive -- cars such as BMWs, Mercedes and Acuras. They lose a little less than half their value after five years and 75,000 miles

The percentages that follow the model show the estimated residual value after five years; the smaller the percentage, the more depreciation is projected to occur and the lower would be the residual value.

These Edmunds.com depreciation percentages are based on the national True Market Value (TMV), a proprietary Edmunds.com calculation that is different from the manufacturer's suggested retail price (MSRP). The TMV is based on transactions throughout the country and Edmunds.com believes it is more in line with what consumers are actually paying than is the MSRP.

Here are the top 10 from Edmunds with the percentage of retained value:

  • BMW Z8 54 percent
  • Mercedes Benz C class 54 percent
  • Mini Cooper 53 percent
  • Porsche 911 53 percent
  • Porsche Boxster 53 percent
  • Lexus SC430 52 percent
  • Acura TL 52 percent
  • Honda s2000 52 percent
  • Dodge Viper 52 percent
  • Lexus GS300 52 percent

    Here are the bottom 10:

  • Hyundai Accent 20 percent
  • Kia Spectra 22 percent
  • Chevrolet Cavalier 23 percent
  • Dodge Neon 23 percent
  • GMC Sonoma 23 percent
  • Dodge Intrepid 24 percent
  • Pontiac Sunfire 24 percent
  • Pontiac Grand Am 24 percent
  • Chevrolet S-10 24 percent
  • Dodge Stratus 24 percent

    Another company, LeaseCompare.com, helps consumers compare leasing programs from competing banks using a three-year term and MSRP rather than Edmunds' five-year term and TMV. Their worst 10 and the retained value:

  • Hyundai Accent 22 percent
  • Chevrolet Tracker 2WD 26 percent
  • Mazda 2300 2WD pickup truck 27 percent
  • Kia Rio 28 percent
  • Oldsmobile Alero 28 percent
  • Chevrolet Cavalier 29 percent
  • Dodge Intrepid SXT 29 percent
  • Kia Spectra 29 percent
  • Mercury Sable GS 29 percent
  • Buick Century 30 percent

    Among popular cars in the $20,000 range, domestic models don't do as well as imports, according to Edmunds.com, which publishes complete listings on residual values. The Ford Taurus SE four-door wagon retains 28 percent while the comparably priced Honda Accord EX four-door will still be worth 49 percent of its original cost after five years. Edmunds says the Taurus will lose more than a third of its value in the first year alone; the Honda about a quarter.

    The popular Chrysler PT Cruiser, with a TMV of about $26,000, will have a residual value of 33 percent after five years. Cadillacs and Lincolns have some of the highest depreciation rates -- as much as 50 percent in one year, compared to cheaper compacts which can lose 35 percent of their value in their first year. The 2003 Lincoln Town Car will be worth about 32 percent of its TMV in 2008.

    Cars.com also has studied residual values over three years. Its top 10 includes many of the same cars as the others, but placed at No. 5 the Honda Odyssey as retaining 60 per cent of its MSRP of $27,360; and the Toyota Tacoma at No. 10, retaining 57 per cent of its $22,335 MSRP.

    Edmunds.com senior analyst Jesse Toprak says consumers should pay as much attention to retained value as monthly payments if they plan to keep a vehicle only a short period.

    "If you are going to keep the vehicle for five years or longer, the depreciation rate will not have as dramatic an effect," he says. "But if you are going to trade it in a few years you should look closely at depreciation -- you have to look at the total cost."

    Depreciation and residual value are absolutely critical in a lease because your monthly payments are primarily determined by a car's estimated residual value.

    Here's how:

    All lease prices start with the residual value -- the amount the car will be worth at the end of the lease. Regardless of the MSRP, the monthly lease amount equals the amount of depreciation divided by the number of months of the lease term -- plus interest and a few added charges to make sure the dealer makes money. You are paying for the amount of its value you use -- the estimated depreciation -- during the lease.

    Lenders usually set the residual value, and it's not a number you can negotiate. You can, of course, negotiate the price, and that affects your monthly payment because the depreciation you're paying for is the difference between the price and the residual value.

    So vehicles that depreciate more slowly are going to have lower monthly lease payments. That's why a Mercedes can have a lower lease payment than a van. It's also why the least expensive cars on the road are poor candidates for leasing.

    Take a Chevrolet Tracker with an MSRP of $17,155 and a residual value of only 17 percent. A simplified transaction would look like this: After three years, that car has a residual value of only $2,916 and would have used up $14,239 of its value. Its monthly lease payment (not including interest and fees) would be $14,239 divided by 36 months, or $396 a month.

    Now compare that with the Toyota Tacoma that has an MSRP of $22,235 and a residual value of $13,100 in three years -- 43 per cent of its original value. Dividing the depreciation into 36 monthly payments produces a monthly lease payment of $254. Its original price was $5,000 more than the Tracker but you could lease it for roughly $140 a month less!

    A Mercedes CLK with an MSRP of $50,670 loses only 36 percent of its value over three years ($17,770) to produce a monthly lease payment of $494 -- just $100 more a month than the Tracker.

    That is the power of residual value.

    -- Posted: Dec. 9, 2003