Car finance: how residual values affect your monthly car payments

Cars with low residuals can leave you with huge PCP finance monthly payments. Pick the right car, though, and you can slash your payments

BuyaCar team
Aug 5, 2019

If you’re considering PCP finance, residual values play a huge part in shaping the monthly payments you have to make. It’s a similar story with PCH leasing, as with both formats your monthly payments effectively cover the difference between what the car costs at the beginning of the contract and what it’s expected to be worth at the end.

Used car finance deals

Residual values don’t impact monthly payments with hire purchase deals, however. That’s because what you pay every month is simply the cash price of the car minus any deposit you make, with interest added on top. This is then split into a series of monthly payments with nothing left to pay once you’ve finished the equal instalments - as you are then the car’s legal owner.

PCP car residual values explained

PCP finance offers lower monthly payments than a traditional car loan, because your monthly payments only cover the difference between the car’s initial price and its predicted value at the end of the contract - rather than the whole value of the car. This predicted value is known as the optional final payment.

If you want to buy the car when the contract ends, you then make the optional final payment - which is based upon its residual value. As a result, the higher a car’s residual value, the lower your monthly payments. The downside of high residual values, however, is that you’d have a bigger bill at the end of the contract if you wanted to buy the car outright.

Finance a £20,000 car that’s expected to be worth £12,000 after three years and your monthly payments will equal £8,000 - the amount the car has lost in value - minus any deposit you pay, with interest added.

For simplicity, assume that this was a 0% APR offer - meaning no interest is added - and that you put down no deposit. That £8,000 cost divided by 36 - the number of monthly payments on a three-year contract - means you’d have to pay £222 per month.

However, another £20,000 car could cost you far more. Choose a car with lower residual values that was only worth £8,000 after three years - losing £12,000 over the length of the contract - and you’d have to pay £333 per month.

That’s a 50% increase in monthly payment for a car with the same cash price - all because of residual values. This means that cars that retain their value well - those with high residual values - come with lower monthly payments on PCP finance than those that are worth less used.

 

Remember, though, that if you want to own the car at the end of the contract, the car with the strong residual values will cost £12,000 at this stage, while the one that loses value faster is only £8,000 - as you’ve paid off more of the balance through higher monthly payments.

Another factor to bear in mind is that if residual values change rapidly and the car you’re running is suddenly worth a lot less than expected - as happened to diesel models following the diesel emissions scandal - you’re protected with PCP finance. It’s the finance company that takes the hit, not you, as it’s the company that owns the car.

On the flipside, if you were to finance an electric car and demand for used electric cars rocketed during your four-year contract, the car could be worth much more than the finance company predicted due to the stronger-than-expected residual values. If that’s the case, you’re still protected, as you can buy it for the pre-agreed optional final payment at the end of the contract or effectively ‘trade it in’ for a new finance deal, putting the equity - the amount the car is worth over the remaining balance - towards your next car.

PCH leasing residual values explained

As with PCP finance, monthly payments on a lease deal effectively cover the difference between a car’s price new and its expected value when you hand it back. Consequently, the higher a car’s residual values, the lower your monthly payments.

Since you have to hand the car back at the end of a lease, the most attractive cars to lease - i.e cars with high cash prices that are available with affordable monthly payments - are typically the ones with the highest residuals. A good example is the Range Rover Evoque, as monthly payments are often lower than you’d expect considering its high cash prices.

Hire purchase car residual values explained

Hire purchase works like a traditional car loan. You put down a deposit - though this can be very small or even nothing in some cases - followed by a series of equal monthly payments. Once these monthly payments are made, you own the car.

As a result, how much the car is worth at the end of the contract when the car becomes legally yours has no bearing on your monthly payments. If, however, you plan to sell the car at this stage, you’ll get more back by selling a car with a higher residual value than one with a poor residual value.

Anyone planning to sell a car on hire purchase as soon as they’ve paid it off, therefore, would be wise to choose a car that holds its value well, as this will cost less overall.

What influences residual values

Residual values are influenced by a number of variables, but it all boils down to supply and demand. If you have a super-desirable car that many people want, that only sold in limited numbers, its residual values should be sky high.

Meanwhile, an undesirable model - such as an automatic diesel supermini (most small car buyers want a petrol-powered manual car) that doesn’t meet the latest emissions rules - is likely to be worth very little thanks to its low demand and consequently low residual values.

If you’re buying a used car with cash, however, cars with low residuals are the most affordable, since they’ve lost the largest proportion of their original price. So, if you find one that suits your needs - and don’t need to sell too soon, at which stage you may find it hard to shift and get a low price back - this could prove surprisingly affordable.

Specification, manufacturing numbers, fuel type and price

With PCP finance you don’t need to worry about car’s residual values, since the finance company has done the sums for you and set the monthly payments to suit.

If you are opting for hire purchase or paying cash, though, and trying to identify which cars will be in demand a few years down the line, you need to think objectively; what type of driver does a car appeal to, how many potential buyers are there likely to be and how many competing cars will there be when you come to sell?

The greater the demand and lower the supply, the more you can expect to get back for that car. If you’re looking at spacious family-friendly cars and considering a low-specification people carrier - a type of car that is falling in popularity - that doesn’t have air-conditioning and a high-specification petrol SUV - a class of car which is becoming more and more popular - with air-conditioning, parking sensors and a glass roof, you can expect the SUV to have better residual values.

As long as the SUV isn’t many thousands of pounds more expensive, those strong residual values mean it’s likely to cost you far less - whether you go for a PCP finance deal or pay cash and sell it after a few years.

Car makes 

On top of spec, price and fuel type, the brand of car can be a big influence on residual value. Normally make has an impact on all cars made by a manufacturer rather than a specific model, though.

Typically, affordable models from upmarket brands such as Volkswagen and Range Rover have higher residual values than mass market models from mainstream brands such as Vauxhall or Fiat.

Similarly, brands that have a strong reputation for reliability, such as Toyota, can have comparably high residual values. If you are looking for a desirable car with a track record for the best residual values, take a look at our article on cars with the best residuals.

Body styles

The final influencer is body styles. In general, hatchbacks are a favourite with buyers so hold on to their values reasonably well. Saloons are falling in popularity, so expect models which are not seen as desirable, upmarket products to suffer most with low residual values.

Estate cars are normally made in lower numbers than saloon or hatchback equivalents, meaning they can hold onto their value quite well if they are desirable enough. And SUVs are rocketing in popularity, so affordable and relatively economical models are likely to prove desirable to an increasing number of buyers - meaning strong resale values.

New car residual values vs used car residual values 

Drivers pay a high premium to get a new car compared with a nearly-new or used models, so consequently there’s a large hit in the residual value department as soon as you drive a new car off the forecourt. A second-hand car with as little as 1,000 miles on the clock could cost £5,000 or even £10,000 less than many otherwise identical new models.

As a result, if you plan to own a car for three years then a brand new model is likely to depreciate most, while a nearly-new model should lose far less, with its residual values proving much stronger compared with the initial price. Meanwhile, a two or three-year old car should depreciate even less, as it has lost even more of the initial price to begin with, slowing the rate at which it loses value.

After the initial three years, the rate at which used car values fall flattens out, with less value lost each year. From this point on, between three and 15 years a car steadily loses the majority of its remaining value, until all that is left is a tiny percentage of its original price.

Remember though, that a car with a low price tag and low residual value could still work out more cost effective than a car with a high price tag and a relatively high residual value - provided the difference in initial price is large enough.

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