What is car depreciation, and how do you calculate it? #CashNews.co

You’ve probably heard that a new car drops in value the second you drive it off the dealership’s lot. You can blame it on something called car depreciation. Car depreciation is the rate at which a car loses value over time.

Some car depreciation is unavoidable, but you can also reduce its effects. Certain makes and models depreciate at a much faster rate than others. Also, by practicing good driving habits and keeping up with maintenance and repairs, you may be able to minimize the pace at which your vehicle depreciates.

We’ll explain how to calculate car depreciation, how to maintain your car’s value, and how car depreciation should factor into your financial decisions.

What is car depreciation?

Car depreciation is the loss of a vehicle’s value that occurs over time due to a number of factors, like aging and wear and tear. According to Kelley Blue Book, a typical new car loses 20% of its value during the first year. From there, they often depreciate by about 15% per year in the first four or five years, at which point it starts to slow.

A car’s depreciation rate is driven by factors including:

• Make and model: Not surprisingly, a popular make and model will hold its value better than a vehicle without many fans. Brands like Toyota and Honda tend to have good resale value because they have a reputation for being reliable and low-maintenance.

• Mileage: The more you drive, the faster your vehicle will depreciate.

• Vehicle age: Your car’s value is typically less the older it is.

• Maintenance and repairs: A car in good condition that has proof of regular maintenance will retain more of its value.

• Market demands and trends: Your car is only worth what someone else is willing to pay for it, so supply and demand affect a car’s depreciation rate. For example, when gas prices are high, a gas-guzzling SUV is unlikely to fetch top dollar. But cars, in general, depreciated at a slower rate than usual during the COVID-19 pandemic due to increased demand for vehicles, coupled with microchip shortages.

Calculating car depreciation

There are a few different methods for calculating your car’s depreciation. If you’re simply trying to figure out your vehicle’s value, the easiest approach is to use an online car depreciation calculator. However, here are some formulas you can use to calculate vehicle depreciation.

Keep in mind, though, that different car makes and models depreciate at different rates, and you also need to account for mileage and the condition of your vehicle. So, there’s no single way to calculate car depreciation. If you’re calculating depreciation for tax purposes, be sure to consult with a tax adviser.

Straight-line depreciation method

The straight-line depreciation method is the simplest way to calculate the depreciation of a vehicle or any other asset you use for business purposes. The formula is:

(Purchase price – salvage value)/useful life in years = annual depreciation amount

To use this formula:

1. Estimate the salvage value of the vehicle, which is the amount you expect it to be worth at the end of its useful life, as well as the useful life of the vehicle in years.

2. Subtract the salvage value from the purchase price.

3. Divide the figure from Step 2 by the estimated useful life of the vehicle.

For example, suppose you pay $30,000 for a Toyota Tacoma to use in your business. You estimate its salvage value at $10,000 at the end of a useful life of five years.

($30,000 – $10,000)/5 = $4,000 annual depreciation amount

Though this depreciation formula is the simplest approach, it assumes the asset will depreciate steadily over time. With a purchase like a new vehicle that tends to lose a lot of value at the beginning then depreciate more slowly, it’s typically not the best way to calculate depreciation.

Declining balance depreciation method (MACRS)

The declining balance depreciation method, or MACRS, is typically used for vehicles used at least 50% of the time for business that were placed into service after 1986. Under this method, you’re using an accelerated depreciation schedule, which allows you to deduct more of the vehicle’s depreciation early on, when depreciation happens most rapidly. You can use IRS Form 4562 to calculate depreciation using this method.

Online tools and resources for easy calculation

Several websites, like Edmunds and Kelley Blue Book, have calculators that show you the estimated five-year cost to own a vehicle. These resources will show you how much you can expect to pay in your first five years of ownership between the purchase price, car depreciation, and out-of-pocket costs, like fuel, maintenance, and insurance. Many major auto insurance companies have similar tools on their websites.

Tips for beating car depreciation

Depreciation is a fact of car ownership. Though you can’t change the fact that your vehicle will usually be worth less as it ages, there are some steps you can take to slow its rate of depreciation by being strategic about which type of car you choose, following a regular maintenance schedule, and practicing good driving habits.

Choose a car with low depreciation rates

Though you can’t entirely predict what market demands will look like several years out, you can choose a vehicle that has a good projected resale value. The average new vehicle is only worth 45% of its sticker price after five years, but Kelley Blue Book estimates that the following 2023 vehicles (listed with projected five-year resale value) will retain at least 65% of their value at the five-year mark.

However, depreciation is just one of the costs of owning an automobile. Also, consider the costs of an insurance policy, typical maintenance and repairs, and gas when you’re deciding what is the best car to purchase.

Buy a used car

Buying a gently used car is a smart way to beat car depreciation. A brand new car typically depreciates by 20% in the first year. By purchasing a car that’s a year or two old, you can get a car that’s still in almost-new condition at a steep discount. Consider choosing a used vehicle from the manufacturer’s certified pre-owned program.

Maintain your car properly

Having your car serviced regularly will help you avoid expensive repairs and also preserve its resale value. Be sure to follow the maintenance schedule listed in the owner’s manual, get regular oil changes, and keep service records.

Drive efficiently

Aggressive driving habits, like accelerating rapidly, driving over speed bumps too fast, and frequently slamming on the brakes, increase the wear and tear on your vehicle, causing it to depreciate at a faster rate. Your car will also have a higher market value if you can limit the number of miles on the odometer. Consider alternatives to driving your vehicle, like using public transportation, carpooling, walking, and biking.

Practicing good driving habits won’t just help you lessen the effects of car depreciation. You could also save money on car insurance for being a safe driver. And if you don’t drive all that much, consider a form of usage-based insurance known as pay-per-mile insurance.

Take good care of the exterior

Getting your car washed and waxed regularly and repairing scratches and dents will help you maintain its value. If possible, park in a garage or covered area to avoid scratches from falling tree branches and damage to the paint from bird droppings.

Use car depreciation to your advantage

If you use your vehicle for business purposes or a side gig, like ride-sharing, you may be able to deduct at least part of its depreciation at tax time. The rules for deducting car depreciation are complicated, so always check with a tax professional first.

Buying vs. leasing: How depreciation factors in

When you’re in the market for a vehicle, you’ll need to decide whether to buy vs. lease. Here’s how to account for depreciation.

Depreciation when you buy

When you buy your vehicle instead of leasing it, you’ll usually have higher monthly payments, but you’re building equity. If you choose a model that depreciates slowly and doesn’t put a lot of wear and tear on the vehicle, you’ll get more money if you sell the vehicle.

Depreciation when you lease

Though leasing offers lower payments, the downside is that at the end of the agreement, you’ll need to either buy your vehicle or buy or lease a different car. The bulk of your monthly payment goes toward depreciation, and you’re not building equity.

At the start of the agreement, the leasing company will determine its residual value, which is the car’s estimated value at the end of the lease. That’s the amount you’ll pay (plus applicable taxes and fees) if you buy out the lease when the agreement ends. If you lease a $40,000 vehicle with a 60% residual value, the leasing company expects it to be worth $24,000 at the end of the lease.

Buying a car with a high residual value may seem like it will save you money since most of your payments go toward depreciation. But that’s often not the case because a high residual value means you’ll pay more at the end of the lease.

If you don’t buy the vehicle at the end of your lease, expect to pay for any accelerated depreciation. For example, many leases limit your mileage to 10,000 to 15,000 annually. Leasing companies also typically charge you for excess wear and tear.

Read more: What to know about car leasing and insurance

Budgeting for depreciation in financial planning

It’s important to account for your vehicle’s depreciation in your personal finance plan. Due to depreciation, you may owe more than the vehicle is worth, particularly if you made a small down payment or chose a long repayment period.

In this event, you may want to buy gap insurance, which can pay the difference between your loan balance and the car’s actual cash value if your car is stolen or totaled. If you have significant negative equity, gap insurance may not cover all the costs.

Depreciation could make it harder if you’re hoping to refinance your car loan. Some lenders won’t let you refinance if your vehicle is past a certain age or mileage, so if you plan on refinancing, aim to do so within the first few years.

If you owe more than your car is worth, and you’re hoping to trade it in, consider building your savings so you can pay off your existing vehicle loan before making the trade. Rolling your old loan into a loan on another vehicle that’s also depreciating could leave you deeply underwater.

When to sell or trade-in

When you’re ready for a new ride, vehicle depreciation will be a big factor in how much you get at trade-in. As a result, it could also affect how much you pay for your next car.

What’s the best time to sell or trade in?

There are a few times in a car’s lifespan when its depreciation will be especially steep based on its age or mileage. Selling between these milestones can help you squeeze the most value out of your car, according to Progressive:

Age-based milestones:

• Year 1: The biggest drop in a car’s value occurs during its first year. Depreciation typically slows in subsequent years.

• Year 4: Most vehicles aren’t covered by a factory warranty after four years. It’s also right around this mark that many costly repairs and replacements, like new brakes and tires, are necessary.

• Year 8: After eight years, depreciation becomes less about the vehicle’s age and more about its mileage.

Mileage-based milestones:

• 30,000-40,000 miles: General warranties often expire around this time. Also, many vehicles need their first round of costly maintenance at this point.

• 60,000-70,000 miles: Powertrain warranties usually expire and another round of maintenance is often necessary in this window.

• 90,000-100,000 miles: People are often hesitant to buy even a well-maintained vehicle with more than 100,000 miles on the odometer.

Evaluating your car’s remaining value

There are several online tools you can use to estimate your car’s remaining value, such as:

• CARFAX reports

• Edmunds Values

• Kelley Blue Book

• NADAGuides

• TrueCar Values

While some tools use your vehicle identification number (VIN) to provide an estimate specific to your car, you’ll likely have to provide your vehicle’s mileage and estimate the condition of your car. The more details you provide, the more accurate your estimate will be.

Read more: As your car loses value, it’s a good idea to revisit how much car insurance you need

Understanding the trade-off between time and depreciation

Car depreciation doesn’t affect you much until you’re ready to sell or trade in your vehicle. For example, it probably doesn’t matter much if your car loses 15% of its value vs. 20% of its value in the first year if you’re planning to keep it for at least a half-dozen years.

If you want to minimize the effects of car depreciation on your bottom line, avoid trading in your car every year or two. Car values drop dramatically in the early years, even though most vehicles are still in good condition at this point.

Even though another steep drop often happens around the four-year mark, many car owners will benefit from keeping their vehicles past this point. It’s important to weigh the costs of expected maintenance and repairs against the cost of having a new car payment. Often, the cost of the occasional repair for a vehicle that’s a few years old is worth it if you can bank the savings from not having a payment.