What is depreciation?
Depreciation can be one of the biggest costs of car ownership, but it's often overlooked
Matt Rigby
Have you ever wondered why cars that are a few years old are so much cheaper than when they are new? It is normal for new cars to drop significantly in value the moment they are first driven away from the dealership, and that value usually continues to drop as the vehicle gets older.
This is called depreciation, and almost every car is affected by it. The rate at which a car depreciates depends on the car make and model as well as it's age and mileage. Car depreciation plays an important role in monthly finance deals, as cars purchased using PCP finance monthly payments cover the difference between the value of a car at the start of the contract and what it's expected to be worth at the end of the term.
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To put it simply, depreciation is a bad thing for anyone who buys a brand new car, as it's likely to lose a lot of value very quickly. However, depreciation can be good if you want to buy a used car, as the car you're looking to buy should cost less than it did when it was new. Cars usually lose the most value after being sold as a brand new car and once they have become 'used'. After that initial hit of depreciation, cars tend to drop off in value more gradually.
It's worth remembering that car manufacturers have been struggling to make new cars lately due to a global shortage of microchips. As fewer new cars are available to buy right now, used cars have become more in-demand and increased in value. A lot of used cars are currently being sold for more than they usually would, which is affecting the
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New car depreciation
It's normal for new cars to lose a significant portion of their value as soon as they are registered - in some cases up to 20% of its new price. This rapid initial depreciation tends to slow down over time, but a car can easily lose more than half of its value in the first three years of its life.
Buying a nearly new car can help you avoid the initial large drop in value, potentially saving you thousands of pounds over the course of your ownership of the car compared with buying exactly the same car new.
The amount of money a given car will lose can vary wildly, depending on several factors - such as how much they cost to buy in the first place, how desirable a particular make or model is, and how reliable a car is likely to be.
Even the paint colour and some optional extras can affect how much it's worth down the line, so in many cases it's not worth adding thousands of options onto a new car - unless, of course, they're all must-haves for you.
Some cars can lose three-quarters of their new value over the course of three years, while the cars that keep their value best may hold on to more than 70% of their new sale price by the time they reach three years old.
It's important to note, too, that how much a car will depreciate depends on how many miles it covers, and what sort of condition it is in. A three-year-old car with low miles and in near-perfect condition is likely to be worth significantly more than an identical model with a high mileage or in poor condition.
Top-spec cars tend to depreciate more than the same car in a lower specification, but their higher initial price means they may be priced similarly to a lower-spec car after three years. As a used-car buyer, that means you might be able to get a higher specification and more equipment for your budget.
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Used car depreciation
While the depreciation that affects new cars can be a significant cost to new car buyers, the same depreciation can help used car buyers save thousands since those same cars are worth less to buy second-hand.
Low-mileage cars that are just a few months old - such as models used as sales demonstrators by dealers - can offer substantial savings over the cost of a brand new car, despite being barely used. Similarly, if you pick the right car, you can find a real bargain by choosing a well looked-after example of a heavily-depreciating model that has already lost much of its value.
Be aware that heavy depreciation still affects finance payments, so it can sometimes be cheaper to get a more expensive car that loses value slowly (as PCP finance monthly payments don't cover the full value of the car but the amount it loses over the length of the contract). Get like-for-like PCP finance quotes for different cars - with the same contract length, deposit and mileage allowance - and you should be able to see which car offers you the greatest value with the lowest monthly payments.
Slowest-depreciating cars
We've used data from Cap HPI which monitors used car prices, to draw up a list of the slowest-depreciating cars from the past three years. Each one has lost the least amount of value in its class, making it particularly cheap to finance, but not necessarily such a bargain if you're buying a used car in cash, as the initial price is higher.
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Cars with the lowest depreciation
Cars that hold their value
What depreciation means for finance payments
A car's depreciation rate is used as the basis for monthly payments for two of the most popular ways to pay for a car - PCP finance and PCH leasing. PCP finance enables you to make a deposit, pay a series of monthly payments and then you have a choice; you can either hand the car back with nothing left to pay (provided you've stuck to the pre-agreed mileage limit and kept the car in good condition) or make the optional final payment to buy it outright.
Meanwhile, with leasing you make an upfront payment followed by a series of monthly payments. Once you've made the last payment you hand the car back. Provided you've stayed within the agreed mileage allowance and there's no damage to the car, there's nothing more to pay. There's also no option to buy the car.
Personal Contract Purchase (PCP)
The rate at which a car depreciates is used to work out the amount that it's likely to be worth at the end of a PCP finance deal, based on the pre-agreed mileage limit. This is known as its optional final payment, guaranteed future value (GFV), or sometimes the 'balloon payment', and you'd need to pay this once all the monthly payments have been made to take ownership.
The finance company will calculate how much the car is likely to lose in value during the course of the contract. Your monthly payments are calculated to cover the cost of this depreciation, taking into account any upfront deposit you may put down, with interest on top. You can reduce your monthly payments by getting a car that depreciates slowly, although the lower the monthly payments, the more you'll pay in interest, as you're paying off the finance balance more slowly.
At the end of a PCP deal, you can choose to make the optional final payment to buy the car. Alternatively you have the option of handing the vehicle back and walking away, or you can 'trade it in' - using any value in it over the outstanding finance balance to put towards your next deposit - and start a new contract on another car.
Personal Contract Hire (PCH or car leasing)
PCH finance, or leasing, is like long-term car hire. The leasing company purchases the vehicle you want at the beginning of the agreement and then delivers it to you and you run it for the duration of the contract.
At the end of the agreement, the leasing company takes the car back and it's then sold on. Your lease payments have effectively made up the difference - the depreciation - though as leasing is a rental product you are paying to rent the car, not specifically to cover that cost. The less value a car loses, the lower the lease payments can be.
Depreciation's impact on ending your finance early
The initial large drop in value most new cars experience could affect you significantly if you need to end your finance contract early. This is because the car is likely to be worth much less than you owe to the finance company at this point, as the value falls fastest initially and then slows down, while your monthly payments are fixed, with the amount you've paid to date initially lagging behind the loss in value the car has experienced, with your payments catching up towards the end of the contract.
This means that if you end your contract early, you're likely to owe more than what the car is worth at that stage. Settling the finance could involve you selling the car with the agreement of the lender, and making up the difference in the amount owed with your own money, or with negative equity finance. Alternatively, the company may want you to return the car to them and you have to pay a charge to cover the shortfall.
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