Do you know that as soon as you drive a brand new car out of a dealership, it will immediately start to lose its value? 😮 When you calculate the value of the car for a certain period and the mileage it has accumulated, it’s what’s called the residual value. Why is it important to know the residual value of a car? Here’s what you need to know!
Most cars, other that some classic cars, lose their value. This is what’s called depreciation. However, not all makes and models depreciate at identical rates. For example, some models may depreciate slower than others. A car that depreciates fast has a weaker residual value. Typically, vehicles with stronger residual values are those that are in demand in the used car market. So, even if another person has owned the car, a buyer would still be willing to pay a good price for it.
Residual value is also important when you finance a car through a PCP deal because it dictates how much you’ll pay for the monthly repayments. The amount you pay every month actually covers the anticipated value that the car will lose through depreciation. So, if you chose a car with a weak residual value, then it will continue to depreciate more throughout your contract, and this results in higher monthly repayments.
However, if you intend to buy the car at the end of your PCP contract, paying bigger monthly instalments would be worth it. Since the car has already lost a big chunk of its value during your contract period, then the final balloon payment would be relatively smaller. You may also choose to return the vehicle if you don’t want to pay the optional balloon payment or if you don’t need the car anymore.
When it comes to Hire Purchase deals, the residual value of a car doesn’t impact your monthly instalments. This is because the amount you pay each month is the cost of the car minus the deposit you’ve made plus the interest for financing the car. The price of the vehicle is divided across a series of monthly instalments so that by the time you’ve finished the contract, you don’t need to pay anything else. You will be the legal owner of the car.
If you compare the monthly payments between PCP car finance and a traditional car loan, you’ll find that PCP repayments are lower. The reason for this is that the monthly payments for a PCP deal cover only the difference between the initial price of a car and its predicted value by the time your PCP contract ends.
Unlike traditional car loans or Hire Purchase deals, you’re not paying for the whole value of the vehicle. That’s why when your PCP contract is finished, you won’t automatically be the legal owner of the car. You need to pay an optional final payment first before you can own the vehicle.
The optional final payment is also called “balloon payment” in PCP car finance. The amount you would have to pay to own the car is based on the residual value of the vehicle. So, for example, if the car has a higher residual value, your monthly repayments might be lower but then, the optional balloon payment will be bigger.
Say you financed a car worth £20,000 for three years through a PCP deal and it would be worth only £12,000 at the end of your contract. The difference, which is £8,000 is the amount equivalent to the car’s depreciation. You’ll be paying around £222 for your monthly payments, not including interest. When you pay a substantial deposit, then that will be deducted, making your monthly payments even more affordable.
But if you chose a car that’s also worth £20,000 but it has a lower residual value, you’ll pay more for your monthly payments. If the residual value of the car is only £8,000 at the end of your contract, then that means the car’s depreciation over time is £12,000. Your monthly repayment amount would be higher, at £333! That’s why it’s important to know the residual values of cars before signing a PCP contract.
Maybe you’ve heard that electric cars depreciate much slower than their traditional combustion engine counterparts. The demand for electric cars in the used car market is high so it can be a wise decision to buy an electric car and then resell it down the line. But what if you financed an electric car and demand for that certain make and model increased?
In this case, the electric car will be worth more than what the car finance company has predicted. Don’t worry that you’ll have to pay more if you’ll choose to own the car at the end of your PCP contract. The fixed balloon payment is all you have to consider. Once you own the electric car, then you can resell it or part-exchange it for another car if you want.
It might seem confusing but it’s crucial to know the residual value of the car you’re planning to opt for a PCP deal. Bear in mind that cars with low price tags and low residual values might turn out to be more cost-effective for you, depending on whether or not you want to pay the optional balloon payment at the end.
You may check the websites of car finance companies and see if they have a car finance calculator with residual values displayed. This will help you get an estimate of the cost of financing a car. Before signing a PCP deal, be sure to understand everything on it and if you find that there are details that are a bit difficult to grasp, don’t hesitate to ask a representative of the car finance company. They’ll be eager to help you out! 👍