Glossary · UK
What is Residual Value (Car Finance)?
A finance company's estimate of what a car will be worth at the end of an agreement, used to set the optional final balloon payment on PCP deals and the monthly payments that lead up to it.
Full Definition
Residual value, in the context of car finance, is the estimated value a car is expected to retain at a specific point in the future, most commonly at the end of a Personal Contract Purchase (PCP) agreement, where it is formally called the Guaranteed Minimum Future Value (GMFV). Finance companies calculate residual value using industry depreciation data (such as figures from CAP HPI or Glass's Guide), taking into account the specific make and model, expected mileage over the agreement, typical wear and tear, and historical trends in used car values for similar vehicles, to arrive at a value they are willing to guarantee the car will be worth when the agreement ends, regardless of what actually happens to used car prices in the meantime. The residual value directly determines the size of a PCP agreement's monthly payments, since the amount being financed through the regular instalments is the car's price minus any deposit minus the residual value -- a car predicted to hold its value well (a high residual value) results in lower monthly payments for the same purchase price than a car predicted to depreciate quickly (a low residual value), because less of the car's value needs to be paid off during the agreement term. Because the finance company, not the customer, bears the risk that the car's actual market value at the end of the term turns out to be lower than the guaranteed residual value, cars with strong, predictable residual values (often certain popular, reliable brands and models) tend to attract more competitive PCP finance rates, while cars with more volatile or poorly predicted depreciation can be more expensive to finance this way relative to their purchase price.