What Is Depreciation in Car Insurance?

Depreciation in Car Insurance Explained

Young woman looking at cars in a showroom
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Table of Contents
Table of Contents

Depreciation in car insurance is the value lost from a vehicle’s price when new because of factors such as the vehicle’s age, mileage, and condition. Part of what determines the depreciation rate is a car’s year, make, and model. 

Insurers use your car’s depreciation to calculate its actual cash value (ACV), determine claim payouts in total losses, and make other evaluations. Collision and comprehensive insurance, for instance, may replace your car in a covered claim if it’s damaged beyond repair, but insurers typically only cut a check for its ACV (minus your deductible)—not the amount you’d need to buy the same car in a newer make or model.

How Car Depreciation Works

Depreciation is a type of accounting method that shows how normal use affects your car’s value over time. It’s not necessarily the last say on your car’s market value, but it gives a rough estimate of your car’s worth. This is helpful for insurers calculating your policy premiums, because your car’s value is often one of the top factors considered.

In general, you’ll find depreciation to be your car’s purchase price minus its potential sale price. It’s calculated by taking your car’s initial value and applying an average annual depreciation percentage to each year you plan on owning it. Cars usually depreciate quickly and significantly in just a few years, even if they’re in good condition.

Depreciation continues to affect a car until its value on paper is zero, regardless of its actual condition. If a zero-value vehicle is totaled, you may not receive enough from your insurance company to replace your car or finish paying off your loan.

Several factors determine your car’s ultimate value (see below), but the average car loses up to 60% of its suggested retail price (MSRP) in the first five years, dropping by 20% in the first year alone and then 15% annually in the other four years. For example, say you have a car with an MSRP of $24,770. Here’s how its estimated worth declines as its total depreciation amount rises, based on average depreciation rates and expected years of ownership:

  • $20,906 after the first year ($3,864 depreciation)
  • $17,645 after the second year ($7,125 depreciation)
  • $14,892 after the third year ($9,878 depreciation)
  • $12,569 after the fourth year ($12,201 depreciation)
  • $10,608 after the fifth year ($14,162 depreciation)
  • $7,557 after the seventh year ($17,213 depreciation)
  • $4,543 after the 10th year ($20,227 depreciation)

New cars start to lose value the moment they’re driven off the lot. The first few years are when depreciation is the heaviest, then it slows. Buying used cars after the hardest-hitting depreciation years can not only help you save money, but can also mean you may recoup more of your investment when you eventually sell the car.

Knowing your car’s market value is important for making informed coverage and vehicle repair decisions and ensuring you have the protection you need. For instance, if your current car loan is higher than your car’s market value because of depreciation, opting for gap insurance can cover the difference so you’re not stuck paying for a vehicle you don’t own outright after a total loss. Gap insurance is offered by many insurers as a policy add-on to collision and comprehensive coverage for about $20 per year, which is usually cheaper than buying it through the dealer at purchase time. 

Factors That Determine a Car’s Value

In addition to your car’s initial price and age, some other factors that may affect your car’s ultimate value are:

  • Vehicle type: Alternative-fuel and luxury vehicles often have higher depreciation rates than more durable ones such as pickup trucks.
  • Vehicle color: Cars with trendier colors may not retain as much value as those with standard colors such as black, white, or silver.
  • Vehicle features and modifications
  • Initial vehicle cost when new: Lower-priced cars have higher demand and therefore tend to depreciate less.
  • Accident history: Major past accidents may lower a vehicle’s market price.
  • Mileage: High mileage means there’s more wear and tear on the transmission, engine, and more, reducing a car’s overall value.
  • Make and model: Makes or models with known problems may depreciate faster; some makes or models also retain value better than others. 
  • Overall vehicle condition
  • Local selling prices for similar cars

The Jeep Wrangler, for instance, has the lowest depreciation rate after five years, depreciating only about 30.9% in that time. On the other hand, a BMW 7 Series depreciates an average of 72.6% by the five-year mark. 

Insurers choose to weigh different factors to determine depreciation and ACV. State Farm, for instance, says it bases your car’s actual cash value on “its year, make, model, mileage, overall condition, and major options—minus your deductible and applicable state taxes and fees.” GEICO uses your vehicle’s mileage, features, add-ons, modifications, existing damage before the claim, and recent sales prices of comparable cars in your area to determine its worth.

You don’t have to accept what insurers say your car is worth in a claim if you don’t think it’s fair. You can compare the insurance company’s vehicle evaluation report against other sources like the Kelley Blue Book and similar vehicles for sale in your area, and use these numbers to negotiate with the insurance company.

Also, you can minimize your car’s future depreciation by buying a high-resale model and choosing a used car over a new one. Keeping your car in good shape by following the recommended maintenance schedule (and maintaining records) and driving less than average also help keep your car’s value up.

Key Takeaways

  • Depreciation is the value your car loses over time because of its age and everyday wear.
  • Depreciation is roughly estimated by using your vehicle’s MSRP and average annual depreciation rates.
  • Insurers use depreciation to calculate your car’s actual cash value, which then is used to make decisions about repairs, total loss cases, and claim payouts. Insurance companies consider multiple factors to determine ACV.
  • It’s important to know your car’s depreciated value to get a fair price when filing claims, making repairs, trading in or selling your car, and choosing the best insurance coverage for your needs.