Residual Value

Meaning and Definition

Residual value, also known as the guaranteed future value (GFV), is the estimated value of a vehicle at the end of a car finance agreement. It is the projected worth of the vehicle after accounting for depreciation and usage over the loan term. Residual value is often used in certain car finance agreements, such as Personal Contract Purchase (PCP), where the borrower has the option to make a final payment (balloon payment) to own the vehicle at the end of the term.

Why it is important to know

Understanding residual value is important for borrowers considering car finance agreements that involve an optional final payment or the return of the vehicle at the end of the term. Residual value affects the total cost of the finance agreement, as a higher residual value generally results in lower monthly payments. It is important for borrowers to consider the estimated residual value when assessing the affordability and long-term financial implications of the car finance agreement.

Example in car finance

Suppose a borrower enters into a Personal Contract Purchase (PCP) agreement for a car with a total cost of £25,000. The agreement has a loan term of three years, with an estimated residual value of £10,000 at the end of the term. The borrower makes monthly payments based on the difference between the total cost and the estimated residual value (£25,000 - £10,000 = £15,000). At the end of the term, the borrower has the option to make a final balloon payment of £10,000 to own the vehicle or return the vehicle to the lender without further obligations. The residual value plays a significant role in determining the borrower's options and overall cost of the car finance agreement.