Depreciation is a word you’ve probably heard in relation to both new cars and used cars, but how important is it? In short, depreciation is a car’s loss of value over time, and it can have a big impact on your finances whether you’re buying, selling, or leasing a new or used car. Here’s our guide to car depreciation.
What does depreciation mean?
Depreciation is the loss of value over time. It happens to the majority of things you buy – clothes, electronics, furniture and most other consumer goods. Depreciation is a constant process, but you’re usually only aware of it when you plan to sell something you own to someone else.
Even after a fairly short amount of time, the item’s value will usually have dropped from the price you originally paid when it was new. That drop is the item’s depreciation. In most cases the process of depreciation continues over time until the item is of little or no value. How quickly that process happens is known as the depreciation rate.
What causes depreciation?
There are many factors that cause an item’s value to depreciate. Electronics depreciate as technology improves. Clothes depreciate as fashions change. These factors – along with many others – also cause your car’s value to depreciate.
A car’s popularity, reliability, efficiency and maintenance costs all factor into its depreciation rate. Different cars depreciate at different rates depending on how much they’re affected by these factors.
Some things are out of your control, but there are others that you, as the car’s owner, can influence. Simply using a car causes depreciation. The more miles you do, the less your car will be worth as its components gradually wear out.
Still another factor that can make a big dent in a car’s value, especially when it’s new, is tax. All new cars are subject to VAT at a rate of 20 percent, which adds thousands of pounds to the price. And there may be other charges that the car manufacturer and dealer add on top. In the majority of cases, the amount of VAT and any extra costs you’ve paid are immediately wiped off the value of a new car the second you take ownership of it.
Luckily, when it comes to the majority of used cars, there is no VAT to pay although dealers will add their own costs into the asking price. Fortunately, that’s usually quite a small amount.
How is depreciation calculated?
A new car’s depreciation rate is often given as a percentage representing how much value will be lost during the first three years of its life. You can use that percentage to work out what the car will be worth when it’s three years old. Here’s an example:
A new car that costs £20,000 when new and depreciates by 50% will be worth £10,000 after three years.
Depreciation rates are sometimes given in terms of ‘retained value.’ In the example above, the car has a retained value of 50%. Which means that, after the first three years, it’s worth 50% of what it cost when new.
A car’s rate of depreciation reduces over time as its value goes down. Cars depreciate the most in the first year, in large part because of the taxes and charges mentioned. After 10 years, the depreciation rate may have slowed to only 1% or 2% a year.
Depreciation rates are estimated before a car even goes on sale. Car industry experts analyse how a car will be affected by the factors we mentioned earlier and calculate the depreciation rate accordingly. They don’t always get it right, but the numbers they come up with are extremely important.
Why does depreciation matter?
Studying depreciation rates is helpful when buying a used car because you may be able to spot a real bargain. It’s amazing how much value some cars lose in the first few years of their lives, which can make them fantastic value as a used buy.
Conversely, you don’t want to be the first owner of a car that’s going to lose tens of thousands pounds of value by the time you come to sell it. Studying depreciation rates can help you avoid falling into that trap.
Depreciation rates also determine the cost of getting a car on a lease or a personal contract purchase (PCP) deal. Car leasing rates and the cost of a PCP are based on the predicted value of the car when the term ends. In essence, your lender tells you the guaranteed future value for your car and your monthly payments cover the cost of depreciation during the time you have it.
What type of cars depreciate the least?
There’s no hard and fast rule about what type of car loses the least value. In general, though, cars that are popular tend to lose relatively little of their value. It’s a simple case of demand vs supply. Big SUVs such as the BMW X5 are very fashionable and many of them have low depreciation rates. As do most electric cars.
It’s worth noting that there are very few cars that lose less than 50% of their value in the first three years. And anything up to 60% can be considered a pretty good return.
There are some exceptions to the rule. Some cars actually appreciate in value over time, meaning that they’re worth more when you sell them than when you bought them. This is the case with many classic cars, some rare sports cars and even some nearly-new electric cars.
What type of cars depreciate the most?
There’s no hard and fast rule about which cars depreciate the most. Again, a car’s popularity is a good predictor. Large saloons and MPVs, for instance, have fallen from favour in recent years and can have high depreciation rates. Equally, some popular models have high depreciation rates because there are a lot of used ones on the market. Many luxury cars have high depreciation rates because they can be expensive to maintain as they age.
How do I minimise depreciation?
A good place to start is by buying a car with a low rate of depreciation. Other things you can do include keeping the mileage to a minimum and keeping the car in good condition. Cars that have been looked after properly hold their value longer.
That said, you shouldn't let concerns about future value dictate what car you buy and how you use it. You should always buy the car you love and use it in a way that suits your needs.
Looking to sell your car and wondering how much it's worth? Check out our free car valuation calculator for an instant quote.
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