It's one of the most important things to research before buying a new auto. Here's why.
For many people, researching a new car entails asking friends how they like their cars, flipping through automotive magazines and searching the Web for competitive prices in your area.
That's a good start, but there's one more stone that shouldn't go unturned: residual value.
A vehicle's residual value affects everything from how much it'll fetch when you trade it in to the size of the monthly payments on a lease. It's the second largest determinant, after purchase price, of a car's actual cost of ownership, says Jesse Toprak, director of pricing and market analysis for Edmunds.com, an auto Web site. While the average car is worth 35% of its purchase price after five years, according to Kelley Blue Book, some can hold onto 50% of their value, while others just 20% or less. If you don't shop around, you could find yourself practically giving your used car away rather than putting the proceeds toward another vehicle.
Still unconvinced that residual values matter? Here are five things that could change your mind.
1. Owning Your Car
Residual value directly affects how much you'll get for your car when you sell it or trade it in a dealership. What many people don't realize is just how much resale value can vary, even for cars within the same class that sell for nearly the same price.
Consider this example within the luxury segment. A BMW M3 has a sticker price of $43,205, while a Cadillac DeVille goes for $42,040, according to Edmunds.com. After five years, however, the BMW is expected to hold onto nearly 50% of its value, or $21,602.50, while the Cadillac should be worth just 29% or $12,191. In other words, it costs a consumer some $8,000 more to drive the Caddy than the Beemer.
Residual value can vary so much that you might even be able to buy a nicer, more reliable car than you thought. A Honda Pilot SUV costs $26,370, according to Kelley Blue Book, while the less prestigious Chevrolet Blazer comes in at $20,565. But after five years, it turns out that the Honda is the better bargain. It will lose only 50% of its value, while the Blazer loses a shocking 80%. In the end, it actually ended up costing you only $13,454 to own the Pilot, compared with $16,452 to drive the Blazer.
2. Selling Your Car
Finding a car that holds its value is also important if you plan to finance it. Why? You never want to find yourself owing more money on your loan than the vehicle is worth, says Ed Powell, chief consumer officer for LendingTree.com. This is what the industry calls being upside down. When it happens, you're stuck with the vehicle until you pay it off. If you can't wait that long, you'll have to cover the difference between the balance of the loan and the amount the car sold for -- a potentially hefty check.
Let's say you buy a Dodge Neon. After two years of ownership, you and your spouse start a family and decide you need a minivan. When you go to sell the car, you find it has depreciated 37%, and is worth only $4,428. The trouble is, you still owe $7,325 on your 60-month loan. (We subtracted Edmund.com's depreciation values from the balance of the loan with a 4.5% interest rate.)
3. Gap Insurance
Your vehicle's true market value is important if the car is wrecked or stolen. What many people don't realize is that your insurance company will reimburse you only for what your car is worth -- not how much is left on your loan. So if your one-year-old compact car gets stolen while you're grocery shopping, there's a good chance you'll owe your lender a lot more than the check you'll receive from your insurer.
One way to protect your savings is to purchase what is called gap insurance. It covers the difference between what the insurance company pays you and how much you owe on your loan if your car is totaled or stolen. Anyone buying a car with poor resale value should consider such a policy, says Mark Brueggemann, senior editor for Kelley Blue Book. At its cheapest, a policy can cost around $500.
4. Zero-Percent Financing Is No Deal
Unless you plan to drive your car into the ground, don't even think about zero-percent financing. This so-called manufacturer incentive is really just another name for increased depreciation. Here's why: When an automaker offers such a deal, it typically offers another alternative -- a cash rebate. That rebate instantly reduces the vehicle's value on the open market. (That's because no one would pay full price for, say, a Dodge Durango, when he could simply walk into a dealership and get it for $2,500 less.) Now add on the regular depreciation that any vehicle suffers, and the owner who grabbed the loan with the low APR will likely be upside down for an extended period of time. Better to take the cash and put it toward the down payment, says LendingTree.com's Powell.
5. Pay More for a Lease
The single most important thing that determines the monthly payment for a lease is the vehicle's residual value. That's because you're essentially borrowing the car against what the lender expects it will be worth after two or three years (plus a financing fee). So cars that hold their value will cost less than ones that depreciates quickly, says Michael Kranitz, of LeaseWizard.com and author of "Look Before You Lease." This is another reason people who can't afford to lay out the cash for, say, a BMW, can afford to lease one. You can compare leases for different cars at LeaseWizard.com. For $34.95, you'll get an auto-lease and loan-analysis kit along with six lender quotes.