Car depreciation - expense that is often overlooked
The decline in the value of a car due to its use or in other words depreciation, is the biggest expense associated with the car and is often overlooked. In this blog we will take a look at it. How does the car value decrease with its use?
Juraj Hrbatý | Personal finance | 21. April 2021
Have you ordered a new car? When you will go to pick up your car, don't forget to sit down comfortably and adjust your seating position before your first drive. Tune in to your favorited channel on the radio, start the engine and hit the road. Enjoy your first kilometre. It will probably be the most expensive kilometer in your life.
After the first kilometer, the price of the car will decline by about 10%. If your car cost EUR 32,000 like my Alhambra, the first kilometre will cost you EUR 3,200. Three euros per meter. Why is that the case?
In all likelihood, you will never be able to sell it again for the price you have bought it for. For someone to buy it, you will have to go down with the price.
In the previous Actual Car Costs blog, I wrote down all the expenses I had with my eight-year-old car and found out that it actually cost me twice its purchase price. Today, I will focus on the biggest expense associated with the Alhambra - depreciation.
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What is car depreciation and what causes it?
Depreciation is the difference between the purchase price of a car and the price at which you are able to sell it for now. The more the car wears out with daily use, the more its value decreases.
Factors that influence the decline in car prices the most:
Mileage: The more mileage you have on your car, the lower will its value be.
Age: Value decreases with age.
Car condition: If the car already looks used at first glance, its price will also be lower. It is therefore necessary to clean the car properly before you plan to sell it. Remove all stains, scratches and so on. If that doesn't help, expect a lower price.
Fuel type, consumption: Fuel-inefficient cars or diesel cars decrease in price rapidly. When some diesel cars were banned from city centres of German cities, their price dropped significantly.
Brand reputation: Some brands like Toyota have a better reputation than others and therefore their value is decreasing less significantly when compared to others. We will come back to this later in the blog.
Previous owner: As the saying goes the fastest-road car is your company car. If something is mine, I try to treat it more gently in comparison to a company car. If I buy a car from an older gentleman, it will probably be in better condition than a company car or a car that was driven by a young "racer".
Consumer behaviour: The automotive industry also has its trends. Currently, the SUVs are popular. Popular cars are unlikely to lose their value their so quickly.
Other factors such as car options (we will get into that later), warranty, associated fees (insurance, service) or safety.
Now a bit of a scientific background. The reasons for the decreasing prices of used cars were also clarified by Nobel Prize-winning economist George Akerlof, who talks about the information asymmetry between sellers and buyers. Dealers know the condition of their cars, but that is not the case for buyers. They know that faulty cars are also being offered. The price asymmetry is nicely explained in this video.
I fully realized the effect of depreciation when my brother-in-law bought VW Sharan last year, which is almost identical to my Alhambra. It has better engine, more add-ons, undamaged, bought from a friend and it's Volkswagen, which has a better reputation than Seat.
From its original price, which I estimate to be at € 37,000, he bought it for less than a third of it, EUR 12,000. It was at that moment that I began to wonder what the new car had actually cost me.
How fast does the value depreciates?
As I mentioned in the beginning, the decline in car prices is very steep at the beginning. In particular, the first three years are crucial. During this time, the value of the car will drop by nearly a half.
In Slovakia, in order to determine the registration fee for used cars, an extensive study on depreciation was conducted in 2016 by the Institute of Financial Planning that belongs under the Ministry of Finance of the Slovak Republic.
I recommend to try out their car value calculator. It shows you a rough estimate of the value of your car, by taking into account the type of car, wheel drive, transmission, engine power, vehicle age and mileage.
There are more sites that can estimate the value of your car. However, in other countries, it is significantly more difficult to gather to data. I only found relevant data for the US market on Edmunds.com and for the German market on Mobile.de and Allianz.de. The Allianz website, in particular, provides a very good overview of car value depreciation in Germany.
As can be seen from the comparison, the decline in the value of cars is very similar across all of the countries. The values are mostly based on an estimate of an annual mileage of about 15,000 km, resp. 15,000 miles for the US market. From the following table, in which we set the original value of the car at EUR 30,000, some differences become a little more visible:
This table clearly shows that at the beginning, the price of cars in Germany is falling at much faster rate compared to Slovakia. I dare to speculate that this is because in Germany, more new cars per capita are bought (and therefore sold). This means that the supply of used cars is much bigger. On the contrary, (again, I speculate) because of a better care and regular service, their price does not fall as significantly as is the case in the beginning.
We will have a look at the optimal point for buying and subsequently selling a used car in the next blog, and I am already looking forward to it.
How to overcome depreciation
It is nothing knew that some brands are notorious for their unreliability and others are known for their reliability (such as Toyota). However, we cannot only talk about the brands as such, sometimes it is necessary to consider individual models or even years of production.
The German club ADAC annually publishes data on the reliability of cars on the basis of trips made by their yellow angels. For example, my Alhambra is among the worst cars in the middle class, especially the years 2013-2014 (I have fortunately 2012). Before you buy a used car, check the reliability data on it.
If the look is not important to you, consider cars that are the most reliable. According to this ranking, Toyota, Seat, Volvo and Škoda are the most reliable brands.
Luxury cars (especially sedans) and electric cars depreciate on average faster. The problem with electric cars is the battery, with less trendy luxury cars the faster depreciation is caused by low demand. On the other hand, SUVs’ rate of depreciation is lower as the demand for them is currently high.
It makes no sense trying to speculate that the less you drive, the slower the car will depreciate. You buy a car with an intention of using it. No one wants to intentionally crash the car or scratch the paint. However, the best you can do for your car is regular service. You do not have to use expensive authorized services. A cheaper local service can also do the service inspection for you.
How do car options affect the price of a used car?
If you bought a new fully loaded car, I have bad news for you. All those thousands of euros for extras will disappear the moment you want to sell the car.
The most important thing for buyers of used cars is the price. If you put two identical cars with different extras in front of the buyer, one of which will be EUR 1,000 more expensive, as it has sunroof, electrically operated rear windows or better speakers, I know exactly which car will the buyer choose – the cheaper one. Cars with more add-ons will therefore have to adjust their price to cars with less add-ons.
Therefore, if you buy a new car and 25% of the price is for car options, this part of the purchase price will be subject to higher depreciation than the basic part of the car price.
Lastly, a piece of advice
The average US millionaire drives a 4-year-old car with 67,000 km on it.