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How to calculate car depreciation

How to calculate car depreciation and how to reduce it

Most drivers fail to consider the true cost of owning a car, which is vehicle depreciation. Considering that a car’s depreciation rate is an unstoppable factor that lowers the vehicle’s value with every passing year, knowing how to calculate car depreciation is a crucial skill for everyone looking to buy a car.

In this article, we’ll show you what stimulates a car’s depreciation and teach you how to lessen depreciation’s blow so that you can keep as much of your car’s value as possible. You’ll also see different methods to calculate vehicle depreciation so you can plan ahead and see into the future. 

What is car depreciation?

Vehicle depreciation is the rate at which a car loses its value with the passing of time. In simple terms, it is the difference between how much your car is worth now compared to how much it was worth brand-new.

Although a car’s depreciation is largely ignored in this context, it is also the costliest component of owning a car. Understanding vehicle depreciation rates and how they are affected by different factors is crucial if you value your money and want to retain as much of a car’s value as possible over time.

Two brand-new cars of similar value can depreciate at widely different rates, with discrepancies as high as 40% between them in the first three years. But with a little bit of planning, you can make sure that your car will keep as much of its value as possible throughout the years.

How is car depreciation calculated? 

There are numerous ways in which you can calculate car depreciation and they range from primitive to highly sophisticated. Let’s take a look at a few examples.

Car depreciation curve – how much a car depreciates annually

Depreciation is a natural occurrence, intrinsic to car ownership. It simply cannot be stopped, therefore, you can expect your vehicle to depreciate with every passing year. If we take out all other details from the equation, such as how many miles a car is driven annually, the condition it finds itself in at the time of the appraisal, the damages it suffered in the past, etc, you can expect your car to lose about 10% of its value every year for the first 5 years. To that, you can add a 10% drop in value the second you purchase it.

 Let’s say that you buy a new SUV for an initial price of $50,000. The second you drive it home, that same SUV will be worth approximately $45,000. After owning the vehicle for just a year, you can expect to get around $40,000 for it, if you were to sell it.

The price drops gradually every year and by the 10th or 11th year, your car is technically considered to have close to zero residual value, typically somewhere between 10% and 20% of its original price.

Therefore, the simplest (although not the most accurate) method to calculate vehicle depreciation is with this formula:

(9 – car’s age in years)/10 * Original price

Prime cost vs diminishing value

The idea that a car depreciates naturally at a constant pace with every passing year is the principle at the base of the prime cost method of calculating a vehicle’s depreciation rate. The formula is:

Car’s cost x (number of days owned ÷ 365) x (100% ÷ car’s effective life in years)

A better way to calculate depreciation is through the diminishing value method which takes into account the fact that a car loses more of its value in the first years of its life. The formula for the diminishing value method is:

Car’s original value x (number of days owned ÷ 365) x (200% ÷ car’s effective life in years)

Regardless of the method you’ll use, you should know that there is no mathematical way to accurately calculate your car’s depreciation rate. In reality, a car’s depreciation rate depends on numerous factors, something we’ll talk about in the next chapter.

What causes a vehicle to depreciate

There are many factors that go into how much a car’s depreciation rate over time. Some are more important than others and cars that were once identical in terms of value going out the factory’s floor can end up with contrasting price tags just a few years later.

As strange as this might sound, the best time to consider a car’s depreciation rate is before purchasing it. With a little know-how and planning, you could save thousands of dollars from going down the depreciation drain. These are the most important factors that determine a vehicle’s depreciation rate:

The type of the car – electric Vs internal combustion

The type of car that you’ll buy will have a huge influence on its resale value. While electric cars are less expensive to drive due to their efficiency and the low cost of electricity when compared to fossil fuels, they tend to depreciate significantly more than cars powered by internal combustion engines.

Much of the price and value of an electric vehicle stands in the battery pack used to power it. In time, every battery pack becomes less and less efficient, thus its value plummets. Since a set of new batteries is extremely expensive, the value of the entire electric car goes down rapidly as its battery pack ages. Take that into consideration while you calculate the cost of owning your future car – add the rapid depreciation of electric vehicles on top of their low day-to-day cost of operating.

Make and model

We all know that some manufacturers produce better cars than others. For example, when it comes to the reliability and timelessness of their interior and exterior design, Japanese manufacturers are unmatched. No wonder that 6 out of the top 10 cars that depreciate the least in their first five years are Japanese, according to iSeeCars.

On the opposite part of the scale, luxury car manufacturers such as Maserati, make up the bulk of the models that devaluate by as much as 60% over the course of just five years after their production.

As a rule of thumb, economy and medium-class models, produced by manufacturers that have the backing of decades of excellence in terms of reliability behind them, will keep their value over time far better than luxury models ever will.

Mileage

In simple terms, the more you drive a vehicle, the more it depreciates. The average US driver will rank in a little under 13,500 miles every year according to the U.S. Department of Transportation’s Federal Highway Administration (FHWA). But that average can vary significantly if you account for age and gender, with males aged between 20 and 55 driving, on average, 18,000 to 19,000 miles per year, while females over 65 years old have an average of less than 5,000 miles per annum.

Judging by these statistics, you can say that normal depreciation occurs at roughly 1,000 miles driven per month. Any more than that and your car’s value goes down faster.

Age

Cars depreciate the second you drive them out of the dealer’s lot – it is estimated that the average car loses 9% of its value the instant that you purchase it.

Not only that but after just a year of owning a new vehicle you can expect its value to have dropped by a staggering 20%. After two years, your car will only be worth about 70% of the original price you paid for it, and it will continue to depreciate by approximately 10% annually in the first five years of its life. The more you keep a car, the less it’s worth.



Car’s age in years


Car’s value as compared to new, on average
180%
270%
360%
450%
540%

The car’s current mechanical and physical condition

They say that age is just a number, and that statement holds water with cars as well. In the previous subchapter we talked about how age depreciates a car, but what is even more important is the car’s current condition. That means that a vehicle that is 5 years old but has been kept in impeccable condition might be worth more than the same model that is only 3 years old but has been treated poorly by its owner.

Wear and tear play a significant part in the rate at which a vehicle deteriorates. Follow the manufacturer’s guidelines when it comes to scheduled maintenance checks and try to keep your vehicle as pristine as possible, if you want to retain as much of its value as possible.

Another important thing to highlight here is that your driving habits might help bring a car’s value down faster than it should. The “sportier” you drive, the bigger the chances of your car’s components to deteriorate.

Modifications

This part is quite simple – don’t, just don’t do any modifications. Modifications almost always instantly lower the value of a car and when it comes to aesthetic modifications, such as spoilers or distinct paint jobs, they tend to polarize opinions and alienate a huge part of prospective buyers. So not only will you sell the car for less money, but you’ll also have fewer buyers to address in the future.

Car’s specifications and style

There are a few specs that can contribute to a car’s depreciation rate. The most important ones are the car’s fuel economy – a vehicle that guzzles more fuel will generally depreciate faster than a fuel-conscious one and believe it or not, the car’s exterior color, with classic, safe choices retaining more value over time (grey, black, white).

Another aspect to consider is the vehicle’s transmission as automatic transmissions almost always fare better than manual ones. Whether they mostly drive inside the city or out on the highway, US drivers prefer automatic transmissions, so cars fitted with them will attract more interest in the future.

Damage suffered

Another value killer is any sort of accident or damage suffered by the vehicle. The worse the damage is, the lower the vehicle’s value will be in the future. Frequency is also a factor – a car with lots of minor accidents will likely demand a lower resale price, even if its condition is quite good overall.

Number of previous owners

Finally, the last major factor that affects a vehicle’s depreciation rate is the number of previous owners. The more previous owners a car has had, the worse it will depreciate.

How to minimize depreciation

Now that we’ve seen what makes a car depreciate faster, let’s take a look at how you can keep depreciation at bay and make sure that your car retains as much of its value as possible as the years pass by. If you want to lower your car ownership costs by lowering the vehicle’s depreciation rates, here is what you need to do:

Buy cars that retain their value

As mentioned above, some models retain their value much better than others. Avoid going for luxury cars and, if you have the option, buy models that are known and respected for their reliability. An online search for the most reliable models in the car class that you’re interested in will potentially steer you to a better vehicle choice that could save you thousands of dollars in the future.

Don’t skip regular maintenance work

One of the easiest and most important things that you can do to keep your car from rapidly depreciating over time is to follow the manufacturer’s instructions when it comes to scheduled maintenance work. Taking your car in to get serviced will keep it running smoothly and it will give a strong signal to future buyers and appraisers that you took good care of it.

Make sure to keep all the receipts and take your car to authorized service shops as much as possible.

Select the right set of specifications

A manual transmission will make a car’s resale value plummet compared to a similar model that was fitted with an automatic transmission. Bright colors such as yellow, red, and orange also contribute to an exacerbated depreciation rate.

A simple rule of thumb when it comes to choosing specs that won’t take away from the car’s future release value is to anticipate what is likely to still be popular in 3 to 5 years time. A neutral color scheme is timeless whereas polarizing colors will alienate a huge chunk of prospective buyers. A car that is easier and more comfortable to drive because it has an automatic transmission will likely attract more interest than one that’s a bit more challenging by being a manual. 

Don’t do modifications

The second you modify your car, you’re likely throwing money out the window. A new sporty spoiler might look cool but it will drive the car’s resale value down. And so will a funky paint job. And so will a personalized interior.

When it comes to vehicle depreciation, few other things are as costly as modifications.

Buy second-hand cars

This one is a no-brainer, considering that most cars lose about 30 to 40% of their value in the first two to three years of their life.

It might be a great idea to buy a car right after the sharpest drop in value it will register throughout its life, once it turns three years old. That way you can still buy a car that’s likely in great condition and that’s fitted with modern tech and comforts. At the same time, you won’t be the one bearing that 30% to 40% staggering loss.

Keep all service and spare parts receipts

Solid proof is always better than words. No need for prospective buyers or appraisers to believe that you took the car in for every service appointment and that you only used original spare parts, when you have the receipts to prove it.

Not only that but being tidy and organized with the car’s documents and past receipts makes you look like the sort of owner that takes care of your possessions, which in turn ups the perceived value of your car.

Prepare the car for the selling process

Another extremely easy thing to do to increase the residual value of your car is to prepare it for the selling process. Simple things such as getting a car detailing package will go a long way. Imagine going to inspect a second-hand vehicle and it looks and smells like an oversized ashtray inside. Of course, you’ll be less tempted to buy it and if you do, you’ll likely offer the seller less money for it than you would if the car would’ve been spick and span, smelling fresh.

Replace broken headlights, get a new shift knob if the old one looks worn out, and fix the radio. Complete every small job that you can think of that will make the car more presentable and thus more desirable for prospective buyers. You don’t have to spend a lot of time and money to get your car looking good again. 

Offer a full history check to show the real condition of your car

If you’re the seller of a second-hand car and you have nothing to hide, then there’s no better investment that you can make than buying a full history check for your car. It takes literally just a few minutes to obtain, and it is solid proof that your car has no skeletons in its past.

With a history report, you can also prove that:

  • the odometer readings are real (many sellers roll back the mileage of their cars to get more money for them)
  • your car has never been stolen
  • your car was not heavily damaged
  • your car wasn’t used as a rental or taxi

All of these facts count, and you’ll have a far better chance of getting top dollar for your second-hand car.

If you know how to calculate your car’s depreciation rate and, more importantly, what to do to minimize it, you’ll be able to save thousands of dollars from going down the drain. A few simple choices and actions can make a huge difference in what your car is worth when it’s time to sell it on. 

FAQ

How much does a car depreciate per year?

There are many factors that go into a car’s annual depreciation rate, so coming up with a reliable general figure is impossible. That being said, you can get a ballpark figure by calculating 10% of the car’s initial price. 

Which is the best method to calculate the depreciation of a vehicle?

There is no reliable mathematical method to calculate the depreciation of a vehicle. In reality, a car’s depreciation depends on too many factors. However, you can estimate the depreciation by subtracting the car’s current value from its original price.

How is the depreciation rate calculated?

You can use either the prime cost method or the diminishing value method to calculate a car’s depreciation. Or you can simply subtract the car’s current value from its original price. However you choose to calculate your car’s depreciation, just remember that you’ll get an estimate not a firm figure.

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