There’s a common saying that a new vehicle loses value the second it leaves the dealership lot. It’s not terribly far from the truth: According to Edmunds, the average $30,000 sedan depreciates nearly $6,000 in its first year of ownership and loses more than half of its original value by the fourth year. Depreciation makes trying to resell your vehicle down the line a dicey proposition, and it can also have a severe impact on your auto loan.
Definition of depreciation
Depreciation is different for every vehicle, but it tends to start with a large initial drop followed by a longer, slower decline. For this reason, CarsDirect points out that unless you somehow purchase a vehicle for far below market value, your new vehicle is going to be worth significantly less than you paid for it shortly after you began driving it. Depreciation can be influenced by factors like supply and market demand, too. If you purchase a rare or limited-edition vehicle, for example, you may actually be able to resell it down the line at a profit if there are enough interested buyers in the market.
Turning upside down
Since depreciation occurs quickly at first, driving a vehicle for a few years and selling it at market value could result in becoming “upside down” on the car loan. Because you pay a fixed rate on your auto loan every month that is likely quote lower than initial depreciation, you are liable to owe more than the vehicle is worth if you decided to sell it. Because the amount owed on the loan is now greater than the value of the asset, you would be forced to pay the difference out of pocket, which would create significant financial strain if you plan to make a down payment on a new vehicle.
Methods of avoiding the flip
In order to keep from being upside down on your auto loan, NADA Guides recommends paying for 20 percent of a vehicle’s price tag as a down payment. By doing so, you won’t have to borrow as much from a financial institution, will pay less in interest over the life of the loan and will likely have lower monthly payments. It will also help safeguard you against turning upside down by nearly or completely offsetting the effects of depreciation in the first year.
Kelley Blue Book also recommends considering a used or certified pre-owned vehicle. You could potentially purchase a year-old vehicle that’s gently used and features many of the same advanced features as the current version for only 80 percent of the price. With a large brunt of the depreciation already paid for by the original owner, you’ll stand a better chance of staying above water on your loan and have a better chance of breaking even or close to it if you should decide to sell it later down the line.
It’s practically a certainty that a vehicle will lose a significant chunk of its value in the first five years of ownership. Going upside down on your auto loan does not have to be so certain. By making a larger down payment or considering a pre-owned vehicle instead, you will be in a better position to stay afloat.