Understanding depreciation, residual value in a lease

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.

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"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.