What are residual values?
Residual values show how much a car will be worth over time, influencing PCP finance payments and how much buyers get back when they sell
As soon as a car is driven out of the showroom, it begins to lose value. When its value is calculated after a period of time and mileage has been racked up, this is called its residual value. It's an important figure, even when financing a brand new car with PCP finance or paying with cash, because how much the car is worth after a few years is potentially the largest cost it will incur its owner.
Virtually all cars lose value - known as depreciation - over time, but not all models depreciate at the same rate. Those which depreciate more or less are said to have weaker and stronger residual values respectively, and there can be several reasons why they differ. Cars with strong residuals tend to be more desirable second-hand and more in demand, which helps push their used prices up.
Strong residual values mean cash buyers get more money back when they come to sell, thanks to the car being worth a higher proportion of its original value. On the other hand, a car with a poor residual value will be worth a much smaller percentage of the initial purchase price.
Residual values can have a similarly big impact on car finance and leasing monthly payments too - whether you’re looking at PCP finance or PCH leasing deals. That's because monthly payments for both options cover the anticipated loss in value from depreciation. Therefore, a car with weaker residual values loses more value over the length of your contract, resulting in larger monthly payments.
However if you're intending to keep the car at the end of the finance period, it might be worth paying off those bigger monthly sums. This is because a car that has lost more value while you were completing your monthly payments will be left with a much smaller final payment at the end, so there is a light at the end of the tunnel in that sense.
If you’re looking to get a car on PCP finance for a set monthly budget, therefore, it’s best not to focus too much on cash prices, as higher cash prices don't necessarily result in higher monthly payments. Some £30,000 cars cost less per month than other £25,000 ones, for instance - as the cheaper car could lose value more quickly This is an important consideration if you're intending to hand the car back at the end of your finance period.
On the other hand, it’s the cash price that's most important when it comes to Hire Purchase monthly payments. A car with a higher list price will always cost more per month than one with a lower value (provided the contract terms are the same). However, if you're planning to sell the car after a few years, you'll still benefit from choosing a model that retains its value well - as you'll get more for it when you do trade it in.
Cheaper used car finance
Used car finance is typically the best value option if you're trying to save some cash. Cars lose value quickest when they go from being a new car to a used car. For most cars, what is initially a dramatic drop in value gradually levels out as the car gets older.
This means that monthly payments for a PCP finance deal on a used car are likely to be even more affordable, because the car loses value more slowly at this point, resulting in lower monthly payments.
Read our guide about how residual values can affect your car finance monthly payments to master the art of choosing a desirable car with rock-bottom monthly payments.