When you lease a vehicle, you might hear the term residual value mentioned by the salesperson. But what exactly is residual value? And what effect does it has on your lease payment?

The residual value is the amount you can buy the car for at the end of the lease, if you decide you want to purchase the car. It also is an important number in the lease equation, directly affecting your monthly payment. So, where do they get the residual value? And what does it mean?

Let's start with a simple definition of residual value. In fact, let's just look at the word residual. Residual means the part that is left after some of it has been taken away.

Ok, so how does this apply to leasing? Well, when you lease a car, you pay for that portion of the car's value that you use.

Say you decide to lease because you don't want to make a large down payment, and you want low monthly payments (this is one of the advantages of leasing over buying). However, three years go by, and you have developed an attachment to the car that you decide to buy the car. If the residual value has been artificially inflated to give you a low monthly payment, you will have to pay more for this car.

So, the bottom line is, you should keep your eye on residual values as you shop for a car, and also when you negotiate your leasing contract. But how can you do this? After all, is the residual something the consumer can negotiate? Where do these values come from?

The banks that issue the lease contracts set residual values. The residual value is their best guess as to what the car will be worth at the end of the lease. They base their projections on data from past models and a prediction of what consumer tastes will be.

In most cases, you can't negotiate the residual value. However, you can — and should — shop for a lease based on the residual value. Going back to the example at the beginning, it is obvious that the less a car depreciates, the less you pay to use it. This is why, when you lease a car, you can afford to drive a more expensive car than when you buy one. You might hear car salespeople say, "You can drive more car, for less, when you lease."

The residual value isn't the only factor influencing your lease payment. But it is one of the most important points to consider. Watch it carefully, and you'll enjoy driving your leased vehicle a whole lot more.