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Residual Values Help Determine Used Car Prices

Residual values on new cars are important to the used car market for both sellers and buyers. They are important to keep in mind when used car shopping because they can vastly affect the price you are going to pay for a used car.

Residual values are predictions made by companies like Automotive Leasing Guide (ALG) on what a new car is going to be worth in three years' time. The values are important because they help a new car manufacturer like Chrysler, for example, determine how much to charge for leasing a vehicle.

By the way, here is an explanation from ALG on how it sets residual values. "ALG has developed state-of-the-art forecasting methodology and cultivated a technical staff with extensive backgrounds in economics and analytics. The ALG staff gathers industry data from a wide variety of sources, including manufacturers and vehicle auctions, and inspects and test-drives every vehicle. They consider all the technical aspects of a vehicle, along with a careful study of each vehicle segment's competition, sales strategy and resale performance, to derive residual values." ALG provides broad guidelines on resale values.

Let's look some more at the case of the Jeep Grand Cherokee. Bloomberg News wrote about the launch of the 2011 Jeep Grand Cherokee. Bloomberg reported, "Changes from the previous model and Chrysler's volume and pricing strategy boosted the residual value of the Grand Cherokee's four-wheel-drive version to 45 percent in the third quarter from 35 percent a year earlier."

What's the lesson a used car buyer can take away from that information?

The 2010 Jeep Grand Cherokee is going to cost a lot less used than the 2011 Jeep Grand Cherokee when both are three years old. That should help you determine how much it is going to cost you to purchase a particular vehicle.

One reason for the significant drop in residual value is the 2011 model is vastly improved over the 2010 Jeep Grand Cherokee. But, and it's a huge but, you actually determine how valuable a vehicle is to you if you have your heart set on a particular model (as people often do when buying a used car).

In the example cited by Bloomberg, a 2010 Grand Cherokee that cost $30,000 new will be worth $10,500 when it is three years old. A 2011 model, at the same $30,000 new, will cost $13,500 when it is three years old. (There's an assumption that both are in the same condition and have the same features.)

With that information in mind, you need to ask yourself the reasons for buying the Grand Cherokee. Is it for practical purposes? Are you buying the Grand Cherokee for its four-wheel drive functionality? Because you like its cargo space? Or, are you buying it for passionate reasons because you like the new design and want to have all the latest bells and whistles?

For practical reasons, the 2010 model is going to serve you jut as well. For passionate reasons, the 2011 model might meet your needs, but at a 30 percent premium in price, which is fine if you can afford the difference.

Another way you can use residual values is to determine how much the used vehicle you are buying is going to drop in value for the first two years you own it. The best way to determine this is via a search engine. Go to Google, for example, and type in the model year, model name, and five-year residual value (i.e. 2010 Grand Cherokee five-year residual value).

The information is valuable to you if you sell used cars quickly. Otherwise, if you own them for a long time (say more than three years) residual value should not have an impact on your buying decision.

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