Depreciation is where a car loses value over time. It happens to all cars but at different rates depending on the desirability, cost, perceived brand value and current market but is usually at a fairly predictable pace. So how does this factor into a car loan?
A brand new car will depreciate between 40-50% within the first five years of ownership. Part of the car loan calculation will be current value versus end value when the loan is fully paid off. The lender wants to make sure that if you default, the car will be worth enough for them to make their money back if they need to sell it.
What Causes Depreciation?
As mentioned at the top, there are many factors that cause depreciation on cars. Some of it is out of your control while you can influence other aspects. Influences include:
Manufacturer: Some vehicle manufacturers are valued more than others. For example, premium manufacturers such as Lincoln are known for quality which means they can depreciate slower.
Model & options: Some vehicle models are more desirable than others. For example, sedans are now worth less than crossovers or SUVs because the market is in favour of those latter vehicle types. Options such as navigation or advanced safety features make a car more desirable, which slows depreciation.
Year & mileage: The age of your car when you plan to sell it and the mileage it will have covered factor highly in depreciation. The older the car, the less it is worth. The more miles it has covered, the less it is worth.
Condition: Vehicle condition affects its resale or trade-in value. This is a factor you can influence. Keep your car in good condition, repair it in a timely manner, repair dings and scratches and look after your car and it could be worth more when it comes to selling.
Reviews & ratings: The safety rating and owner reviews can influence how much a car is worth by influencing its desirability. A highly rated car will be worth more than one that didn’t perform so well.
Safety and gas mileage: If you car has a high safety rating it is worth more. If it gets good gas mileage, it is also worth more.
All these things factor into its resale value, which is also taken into account when calculating a loan. If you’re borrowing over 48 months, depreciation would be calculated or averaged for that period. It takes into account how much you will have paid in that time and how much reselling it would be worth during that time. Your monthly payments would be calculated to stay a little ahead of its value so the lender can always recoup their money should you default.
Depreciation is a minor factor in a car loan but is still a consideration. You should consider it as well as the lender as it could influence your choice of car!