What Is Car Depreciation?

Car Depreciation Explained

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Car depreciation refers to a car losing value over time as it ages, racks up mileage, and incurs wear and tear. While it directly impacts your car’s resale value, car depreciation is also a key factor in your car insurance rates and coverage. 

Learn more about car depreciation, how it impacts car insurance, and the key factors to consider when setting up your policy. 

Definition and Examples of Car Depreciation

Car depreciation refers to a decrease in a car’s value, and it begins as soon as you drive a new car off the lot. New cars lose more than 10% of their value within a month of being purchased, according to data from Carfax. State Farm estimates that new cars depreciate by an average of 20% in the first year and nearly 60% in the first five years of ownership.

For example, a brand-new 2021 Ford Escape with a sticker price of $30,985 would be worth an estimated $24,788 after one year and just $12,939 after five, according to State Farm’s calculator.

While industry averages offer an idea of how much cars depreciate over time, various factors contribute to a vehicle’s actual depreciation rate, including:

  • Mileage
  • Vehicle age
  • Internal and external damage
  • Make/model
  • Purchased new or used
  • Demand in the market
  • Features and technology
  • Maintenance history
  • Ownership history
  • Fuel efficiency
  • Color 

Doing some research and asking specific questions before buying a car can help you choose a vehicle with a lower-than-average depreciation rate, which could help you save money over time. 

How Does Depreciation Affect Car Insurance?

The value of your vehicle is a key factor in your car insurance policy, as it’s the basis for determining your coverage. Your insurer needs to understand what your car is worth to calculate the costs of replacing or repairing it. In many cases, insurers will give you two options when it comes to considering your car’s depreciation: 

  • Actual cash value (ACV): Pays you the amount your vehicle is worth at the time of a total loss, factoring in depreciation. 
  • Replacement cost: Pays you the amount it will cost to replace your vehicle with a new equivalent vehicle. 

ACV policies cover the value of a vehicle with depreciation taken into account. As time passes and your car depreciates, your policy covers a smaller amount—and you’ll pay lower premiums. However, if you total your vehicle, you will only receive a settlement for its current market value at the time of the loss.

On the other hand, if you opt for the replacement-cost option and your vehicle is deemed a total loss, you’ll receive the amount you need to replace it with a new equivalent one. Your coverage amount does not reduce over time (and could increase), which means your premium will be higher than if you chose an ACV policy. 

How Does Depreciation Affect Financed Vehicles?

If your car depreciates faster than you pay off your loan, you could end up owing more than your car’s worth. If you total your car while you’re upside down on the loan and you have ACV coverage, you’ll have to pay the difference out of pocket. 

Guaranteed auto protection, also known as GAP insurance, is an alternative option that exists to cover any outstanding loan balance that remains after an auto insurance company pays out the value of a vehicle deemed a total loss. 

Because cars depreciate rapidly in the first couple of years, especially in the first year, replacement-cost coverage can prove to be most beneficial when you first finance a new car. It might make sense to switch to ACV as your loan payments catch up to the car’s value. 

What Car Depreciation Means for Car Buyers

Understanding how car depreciation affects your auto insurance rates and coverage is important so you’re not met with an unfortunate surprise. No one wants to end up with no vehicle, a bill for an outstanding auto loan balance, and an insurance check that falls short

You can ensure you’re prepared by weighing your coverage options and choosing the best fit for your situation. In some cases, the extra expense of replacement-cost coverage can offer you the security of knowing you will be able to pay off your loan balance or get a new car if you total your current vehicle. However, ACV can also make sense if saving is a top priority, or if you’re paying off a car faster than it’s depreciating. 

Key Takeaways

  • Car depreciation refers to the decrease in a car’s value over time.
  • Cars depreciate due to a variety of factors, including mileage, wear and tear, and age. 
  • Car depreciation is a factor insurers use to determine your car insurance rates and coverage.
  • Insurers may offer a replacement-cost option that doesn’t factor car depreciation into your coverage or an actual cash-value option that does. 
  • Deciding between replacement-cost and actual cash-value coverage depends on your preferences for cost, replacement options, and financial risk.