One of the key considerations when leasing or buying a vehicle is how well it will retain its value, also known as the depreciation rate.
Our handy guide breaks down depreciation, looking at what factors affect devaluation and how you can avoid losing significant value from your car.
Additionally, you can use our car depreciation calculator to help estimate the depreciation value of your vehicle over time.
What is car depreciation?
Car depreciation is the difference between the car’s value when you buy it and the amount you receive when you sell or trade it in.
Depreciation is one of the biggest overlooked costs when it comes to cars, as a vehicle begins to lose value as soon as it leaves the dealership. Most of a car’s value is lost during the first year of being owned with depreciation generally slowing after around three years. While every vehicle is subject to depreciation, the rate of value loss varies greatly between makes and models.
In leasing, the residual value of a vehicle is how much it is worth once the agreement ends.
With contract hire, you don’t need to worry about depreciation, as your monthly payments take into account the car’s retail price, predicted loss in value, mileage, and condition over the course of your contract.
If a car is worth £20,000 new and your contract is for three years with a 10,000 mileage allowance per annum, the finance company may predict the car will be worth £6,500 once the agreement ends. Therefore, you’ll need to pay £4,500 per year over three years.
How much does a car depreciate each year?
The rate of depreciation typically slows with age. On average, a car depreciates by 15-25% in the first year and up to 60% over three years, assuming it travels 10,000 miles annually.
The average new car depreciates faster than a used model, losing 10% of its value as soon as it is driven off the lot. For example, if you purchase a new car for £33,556, it will lose £3,356 in value as soon as you drive it and around a further £17,780 over the next three years.
To calculate depreciation, you can use a straightforward mathematical approach by applying the average depreciation rate to the car’s initial value.
This loss in value varies between models – while an Audi may depreciate by 40% on average over three years, a Porsche may lose just 25% over the same period. The manufacturer, model, size, condition and year of the vehicle are all factors that affect the car depreciation rate. For example, if the manufacturer has a reputation for reliable, strong and durable vehicles, this can help withstand depreciation.
What factors affect depreciation?
While most cars depreciate, there are some factors that can dramatically impact the amount that a car loses in value. These include:
Vehicle age
The age of a car is the biggest factor in depreciation, as a brand new car depreciates the fastest. Most brand-new vehicles lose around 10% of their value as soon as they’re driven from the dealership and a further 10-20% before the end of the first year. After that, the depreciation levels out to between 15% and 25% per year, for an average loss of 60% by the third year. Because vehicles depreciate the most in the first year, buying a used car can save you roughly 20-30%, as value loss averages 17.5% after the first year.
Instead of buying a new or used car, you could choose to lease. With contract hire, there’s no need to take vehicle age into consideration as the cost of depreciation is included in the monthly payments, based on the car’s expected residual value.
Supply and demand and used car prices
The higher the demand for a car, the less it will depreciate over time. Conversely, if there are more sellers than buyers, resale value may go down. Even the colour of a car will affect the resale value – although a uniquely coloured car may appeal to you, it will narrow down the amount of potential buyers interested in the car when you come to sell. Black, white or silver cars are the best choices to reduce depreciation.
Supply and demand dynamics significantly influence used car prices. For instance, used car prices spiked following the COVID-19 pandemic due to increased demand exceeding supply.
Another factor to take into consideration is the time of year you choose to sell. For example, you may get less for a convertible if you decide to sell during the winter, and less for a 4×4 in summer. Furthermore, if the manufacturer just updated or discontinued your model, the resale value will go down unless it’s a particularly rare or desirable car.
Engine type and electric cars
Although fuel economy alone doesn’t determine depreciation, MPG is a key influencer in resale value.
Larger vehicles and larger engines require more fuel more frequently, meaning they suffer more from depreciation. Diesel cars (i.e. more fuel efficient cars) tend to depreciate slower than petrol cars as they are generally more fuel efficient, with petrol-engine saloons tending to suffer the most.
Mileage
The average mileage is around 10,000 miles a year. Mileage is one of the biggest factors that affects a car’s depreciation – the more miles, the more wear and tear to the vehicle and the less a car is worth over time. If a new car has an RRP of £20,000 and is sold with 40,000 miles on the clock a few years later, it would be worth around 40% less at resale based on mileage alone.
You don’t have to worry about mileage and depreciation when it comes to leasing, as the payments are based on an annual mileage allowance as stipulated in your contract. It’s vital to choose a mileage allowance that accurately reflects your requirements, as you’ll be subject to excess charges if you exceed your mileage limit.
General condition
Electric cars depreciate the same as any other type of car – damage to the bodywork, interior and exterior will reduce the resale value. Modifications like a new stereo, spoiler or alloy wheels can also impact how much a car is worth, as most buyers will prefer purchasing the model in its original condition. It’s important to keep a complete service history of your car, as regular maintenance and proof of your car’s condition will reduce depreciation.
Calculating Car Depreciation
Calculating car depreciation can seem daunting, but understanding it is crucial for making informed decisions when buying or selling a vehicle. One of the most common methods to calculate car depreciation is the straight-line method. This approach assumes that the car’s value decreases by a fixed percentage each year. For instance, if you purchase a car for £20,000 and it depreciates by 20% annually, its value after one year would be £16,000.
Another method is the diminishing balance method, which calculates depreciation based on a percentage of the car’s current value each year. While this method is more accurate, it is also more complex. For example, if the same £20,000 car depreciates by 20% in the first year, its value would be £16,000. In the second year, it would depreciate by 20% of £16,000, resulting in a value of £12,800.
It’s also essential to consider the car’s residual value, which is its worth after a certain period. The residual value can be influenced by various factors, including the car’s make, model, and condition. Understanding these elements can help you better predict and manage your car’s depreciation.
The Biggest Depreciation Hit: Brand New Cars
Brand new cars take the biggest depreciation hit, with some models losing up to 50% of their value within the first three years. This steep decline occurs because new cars are often sold at a premium price, and the initial depreciation is the most significant. Additionally, new cars come with warranties, which can also impact their value.
Petrol and diesel cars are depreciating faster than electric cars due to the growing demand for eco-friendly vehicles. However, not all petrol and diesel cars depreciate at the same rate. Some models hold their value better than others, depending on their make, model, and condition. For instance, a well-maintained diesel SUV might retain its value better than a petrol-engine saloon.
Long-term Depreciation Trends
Long-term depreciation trends reveal that while cars typically lose value over time, the rate of depreciation slows down after the initial hit. On average, car depreciation rates hover around 15-20% per year, but this can vary based on the car’s make, model, and condition.
Electric cars are depreciating at a slower rate compared to petrol and diesel cars, thanks to their rising popularity and government incentives for eco-friendly vehicles. However, the depreciation rate for electric cars can still vary significantly depending on the specific make and model. For example, a high-end electric car like a Tesla may hold its value better than a less popular electric vehicle.
Cars that Hold Their Value Best
Certain cars hold their value better than others, largely influenced by their make, model, and condition. Electric cars, such as the Tesla Model S, are retaining their value well due to their increasing popularity and government incentives for eco-friendly vehicles.
Fuel-efficient cars, like the Toyota Prius, also maintain their value due to their low running costs and the growing demand for eco-friendly options. Additionally, cars with a strong brand reputation, such as the Porsche 911, tend to hold their value well because of their desirability and rarity. These factors make them attractive options for buyers looking to minimize depreciation.
How to reduce the effects of depreciation
Any depreciation values given are only estimations of what the residual value of your car will be by the time it comes to replacing it. If you want to help your car keep as much of its value for as long as possible, some of the simple things you can do include: Cars lose significant value, especially within the first year of ownership, so it’s crucial to take steps to minimize this loss.
Take out GAP insurance
GAP insurance covers the depreciation of your car. It’s designed to cover the difference between what your car insurance provider pays out and what you paid or still owe on the car, depending on the type of policy.
For example, if your car is worth £10,000 and is written off after three years, the insurance will pay out around £5,000 – the market value of the car at the time of the claim, based on a 50% depreciation rate. With GAP insurance, you’d get the full value back – £5,000 from the insurance policy and the other £5,000 from GAP cover.
Lease rather than buy
With car leasing there are no concerns about depreciation as you don’t own the vehicle, so it’s not your responsibility. The payments you make when leasing cover the difference between the value of the car new and the anticipated residual value once you hand it back – in other words, the depreciation.
Even if market conditions lead to your vehicle’s depreciation being greater than predicted, the finance company absorbs this loss – not you. You often find that you pay less over a fixed-term contract than you would if you’d purchased the car and sold it on after the same time period.
Summary
There are many things you need to factor in when working out how to limit the value loss of your next car. However, it’s clear that leasing has a lower financial outlay when it comes to depreciation than buying.
If you’re looking for a new lease vehicle, discuss your requirements with the vehicle leasing team today.
