Purchasing a car requires hours of budgeting, research, comparisons, test drives, and negotiating. The costs of owning a car add up—AAA’s most recent driving expense report reveals that people in the U.S. spend an average of $9,282 a year to own a car.
According to the same report, “Of all costs, depreciation, a measure of how quickly a car loses value, remains the single biggest cost of ownership, accounting for more than a third (36 percent) of the average annual cost.”
Car value depreciation has an immense impact on every car owner’s wallet. When buying a new vehicle or signing up for a new auto insurance policy, you should refresh yourself on how car depreciation works and how insurance providers calculate the value of a vehicle.
Car Value 101
The term “car depreciation” refers to the monetary value that a car loses throughout its lifespan. Depreciation begins the second a new car leaves the lot, and the largest drop in value occurs within the first year of purchase. After that, car value continues to fall but at a lower rate, following a predictable curve.
Why Cars Decrease in Value
New, used, and leased vehicles all decrease in value because of the same factors. These elements include:
- Perception– Due to their brand reputation, prestigious or luxury cars maintain their value longer than common makes and models.
- Reliability– Based on brand perception and consumer surveys, people find some cars more reliable than others, which increases their value.
- Technological Advancements– As car makers add new tech features each time they create a new model, the previous versions that don’t feature technology assets decrease in value.
- New Models– Older models tend to depreciate faster, especially if newer models have major improvements or better incentives for purchase. However, if a maker discontinues a model, it may retain more value due to supply and demand.
- Mileage– The numbers on the odometer directly affect a car’s value; the more miles tracked, the less value the car maintains.
- Condition– Any damage caused to a vehicle directly lowers its value.
However, how you purchase or lease a car does ultimately make a difference in terms of how much value your car loses throughout your ownership:
- New Cars– New cars depreciate the fastest. On average, a vehicle depreciates about 20 to 30 percent the first year and ten to twenty percent each following year.
- Used Cars– As depreciation occurs most drastically within the first year, used vehicles at least one year or older maintain a greater value for the owner.
- Leased Cars– Leasing prices typically include the cost of depreciation, taxes, and interest. If you chose to buy out the vehicle, dealers factor in the residual value of the car to determine the resale price.
How to Calculate Depreciation
Every vehicle depreciates over time, but because so many factors impact the rate of depreciation, calculating costs can be difficult. To get an estimate of your current car’s value or to predict how a new car will depreciate, you can use a free online calculator.
In general, car depreciation follows this formula:
Purchase price – current fair market value and sales tax or fees
Car Value Depreciation and Auto Insurance
Many of the same factors affect car value depreciation also affect your car insurance rates. For example:
- Car Value– The higher the listing price of a car model, the higher the insurance premium.
- Safety– Older car models may not include the latest safety features, or they may have earned a poor reputation for safety. Auto insurance providers factor in safety when determining policy rates.
- Coverage– Coverage needs for a vehicle will change once costs exceed the value of the car.
Considering Gap Insurance
When a car is totaled or stolen, auto insurance companies offer compensation based on the actual cash value (ACV) of the vehicle, which depreciates over time.
In some situations, a car owner will owe more of their car loan than the value of their vehicle when the accident or theft occurs. Should this happen to you, you’ll need gap insurance to cover the costs.
What does gap car insurance cover? Guaranteed asset protection (gap) insurance pays the difference between their remaining loan balance and a car’s actual cash value at the time of the accident or theft. Essentially, gap insurance prevents a policyholder from having to make payments on a car the can no longer drive.
While most states do not require gap insurance, many people add this optional coverage to their car insurance policies.
Expecting the Unexpected
When you buy a vehicle or take out an insurance policy, you should always take the time to consider worst-case scenarios. All cars depreciate in value, and aside from driving carefully, you can’t do anything to stop it. With gap insurance, you can plan for the worst while taking into account the unavoidable cost of depreciation.