What is depreciation?

It's often your biggest overall cost when choosing a car, but it's often overlooked. So what is depreciation?

Matt Rigby
Nov 27, 2020

Ever wondered why cars become cheaper over time? The value of a car will fall as soon as the key is turned in the ignition for the first time, and that value will continue to drop off for every mile it covers.

It's called depreciation, and every car suffers from it, but the severity of this fall in value is dependant on a number of factors, and this can lead to substantial differences in the cost of monthly finance deals.

In the most basic terms, depreciation is a bad thing for anyone who buys a brand new car, but a very good thing for anyone looking for a great value used car. In most cases, the worst period of depreciation is the initial drop, from that car becoming a brand new car to it becoming a 'used' car. Once that initial hit has been taken, the subsequent fall tends to be much more gradual.

Let's say you bought a brand new car for £20,000. On average after one year, your car will be worth around £14,000. By the time you've owned that car for five years, it will be worth less than £10,000.

New car depreciation

In the vast majority of cases, as soon as a car is registered, it will lose a significant chunk of value – in some cases up to 20% of its new price. This rapid initial depreciation tends to slow down over time, but a car can easily lose more than half of its value in the first three years of its life.

Buying a nearly-new car can help to avoid the initial large loss in value, potentially saving you thousands of pounds over the course of your ownership of the car compared with buying exactly the same car new.

The amount of money a given car will lose can vary wildly, depending on several factors – such as how much they cost to buy in the first place, how desirable a particular make or model is, and how reliable a car is likely to be.

The biggest-depreciating cars can lose three-quarters of their new value over the course of three years, while the cars that keep their value best have held on to more than 70% of their new sale price by the time they reach three years old.

It’s important to note, too, that how much a car will depreciate depends on how many miles it covers, and what sort of condition it is in. A three-year-old car with low miles and in near-perfect condition can be worth significantly more than an identical model with a high mileage or in poor condition.

Used car depreciation

While the depreciation that affects new cars can be a significant cost to new car buyers, the same depreciation can save used car buyers thousands since those same cars are worth less to buy second-hand.

Low-mileage cars that are just a few months old – such as models used as sales demonstrators by dealers – can offer substantial savings over the cost of a brand new car, despite being barely used. Similarly, if you pick the right car, you can find a real bargain by choosing a well looked-after example of a heavily-depreciating model.

However, heavy depreciation still affects finance payments, so it can sometimes be cheaper to get a more expensive car that loses value slowly. Get like-for-like PCP finance quotes - with the same contract length, deposit and mileage allowance - and you should be able to see which car offers you the greatest value.

Slowest-depreciating cars

We've used data from cap-hpi which monitors used car prices, to draw up a list of the slowest-depreciating cars from the past three years. Each one has lost the least amount of value in its class, making it particularly cheap to finance, but not necessarily such a bargain if you're buying a used car in cash, as the initial price is higher.

Cost when newValue after 3 yearsDepreciation
City car
Kia Picanto 1.25 2 (2015-16)
£10,690£4,725£5,695 (55.8%)
Small car
Honda Jazz 1.3 S (2015-17
£13,740£6,875£6,865 (50%)
Family car
Toyota Prius 1.8 VVTi T3 (2009-15)
£21,940£12,050£9,890 (45.1%)
Large family car
Jaguar XE 2.0 SE Auto (2015-17)
£26,580£12,450£14,130 (53.2%)
Small SUV
Dacia Duster 1.6 Access 4x4 (2014-15)
£11,090£5,550£5,540 (50%)
Family SUV
Mazda CX-3 2.0 Sport Nav (2015-18)
£20,640£10,400£10,240 (49.6%)
Electric car
Volkswagen e-Golf (2014-16)
£31,625£13,400£18,225 (57.6%)

What depreciation means for finance payments

A car's depreciation rate is used as the basis of two of the most popular finance agreements:

Personal Contract Purchase (PCP)

A car's depreciation rate is used to work out the amount that it's likely to be worth at the end of your PCP agreement, based on an agreed mileage limit. This is known as its guaranteed future value.

The finance company will calculate how much your car is likely to lose in value during the course of your agreement.

Your monthly payments are calculated to cover the cost of this depreciation, taking into account interest payments and any deposit you may put down. You can reduce your monthly payments by getting a car that depreciates slowly (although you'll probably pay a bit more interest as more of the car's price is deferred until the end).

At the end of a PCP deal, you can choose to pay the guaranteed future value to buy the car. Alternatively you have the option of handing the vehicle back and walking away. If the car ends up being worth more than the guaranteed future value, you can trade it in and use the difference towards a new car.

Personal Contract Hire (PCH or car leasing)

PCH finance, or leasing, is long-term car hire. Your finance company purchases the vehicle you want at the beginning of the agreement and then delivers it to you.

At the end of the agreement, the finance company takes the car back and it's then sold on. Your lease payments have made up the difference - the depreciation. The less value a car loses, the lower the lease payments can be.

Depreciation’s impact on ending your finance early

The initial large drop most new cars experience could affect you significantly if you need to end your finance agreement in the first year or two of ownership. This is because the car may be worth much less than you owe to the finance company at this point, as it will have set finance repayments based on a predicted future value.

Settling the finance could mean you need to sell the car with the agreement of your lender, and make up the difference in the amount owed with your own money, or with negative equity finance.

 

Read more about:

Latest jargon busters

  1. Electric car glossary: Electric Vehicle (EV) jargon busted

  2. What is horsepower?

  3. What is voice control?

What our customers say