A Residual Value is the value of the asset at the end of the primary lease term. This value is usually set by the finance company's asset management department or may be a pre-agreed figure with an independent third party. This value is excluded from the capital amount to be repaid within the lease and thus reduces the periodic rental. The potential risk (or reward) in the actual value of the asset at the end of the lease is thus taken away from you.
A balloon is very similar to a residual value in that it is netted out of the capital element to be repaid under the credit or lease agreement. You then benefit from a reduced periodic rental or instalment. However, the balloon is payable by you and the risk or reward in the value of the asset is yours. When the credit agreement includes a balloon figure that enables you to return the goods to the finance company for the balloon value, this is often referred to as a Guaranteed Future Value. It is, for all intents and purposes, the equivalent of a residual value, but for a credit agreement. The potential risk in the actual value of the asset at the end of the agreement is thus taken away from you. Hence, it is very important that when you enter into a credit agreement to ensure you are clear as to whether the final lump sum is a Balloon or Guaranteed Future Value.
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