What is depreciation?

The biggest cost you'll face when you buy or finance a car: depreciation explained

BuyaCar team
Jan 19, 2017
iStock.com / welcomia

Depreciation is the amount of value that a vehicle loses as it gets older and its mileage increases.

In other words, it's the difference between the price of a car when you buy it and its value later, when you want to change it.

Depreciation is often called an invisible cost because you never get a bill for it. Even so, it's the biggest factor in the cost of owning a car, and it also has a major impact in monthly payments for cars bought on personal Contract Purchase (PCP) finance, or which are leased.

The less a car depreciates, the cheaper it will be to own or to finance.


Car depreciation calculator

The depreciation of a car is estimated by experts who predict how much a car will be worth as a used model, based on expected demand from second-hand buyers. These forecasts are used by the industry to calculate finance payments and to set the price for used cars.

But at the end of the day, a car is only worth what a buyer is willing to pay. If it suffers from unexpectedly low reliability, has a safety scare, or just goes out of fashion, then it could depreciate faster than expected.

The depreciation figure most quoted is over a car's first three years. In this time, it's typical for a car to have lost more than half of its new list price, and to be worth around 40% of that.

Any car worth at least half of its new list price is considered to be a low depreciator, and cheaper to own.

You can find out estimated depreciation costs for cars you're interested in as part of the car costs calculator on the government-funded Money Advice Service. It's powered by cap-hpi: one of the companies that predict car values.


Brand new car depreciation

Brand new cars are said to lose thousands of pounds the moment that you drive them away. It's not always true, but it's not far off the mark either. New cars can lose as much as 20% - a fifth of their new price the moment that they are registered to their first owner.

That rate of depreciation then slows down and the vehicle will usually lose value at a far lower rate for the rest of its life.

But that initial large drop could affect you if you've taken out finance on a brand new vehicle and it's written off within a few weeks. Your insurance will only pay out for the value of the car - 80% of its price - but you will still owe the finance company the full cost, minus the few payments that you've already made.

This is where Guaranteed Asset Protection (GAP) insurance comes in useful. It plugs the gap, paying out on the difference between the amount that you owe and the insurance payout.

If you buy your car outright, then you'll suffer from a car's initial large drop in value if you sell it quickly.


Used car depreciation

Obviously cars continue to lose value as they get older, but at a slower rate. Once a vehicle is more than around four-years old, it becomes harder to predict its future value. This means that some types of finance that are based on a car’s depreciation rate may not be available.


How depreciation is used to calculate 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 its guaranteed future value: the amount that it's likely to be worth at the end of the agreement, based on a certain time period and mileage limit.

Your deposit and monthly payments make up the difference between the cost of the car at the start and its value at the end - the depreciation during the period that you have it (plus any interest payments). You can reduce your monthly payments by getting a car that depreciated slowly.

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 or trading it in for a different model.

Personal Contract Hire (PCH or car leasing)

PCH finance 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 usually then sold on. Your lease payments, therefore, have to make up the difference - the depreciation. The less value a car loses, the lower the lease payments can be.



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