Why New Car Depreciation Isn't So Bad

Depreciation is defined as the "decrease in value of an asset due to obsolescence or use." As long as your car stays in storage and the gasoline engine remains relevant, you might be able to avoid depreciation. However, it is simple fact that most motor vehicles, new and used, will lose value after purchase. New cars in particular are notorious for losing on average 11% of their value once driven off the lot. But depreciation must be looked at in a larger context before you should let it affect your car buying decisions.

The problem with depreciation is that people tend to think of motor vehicles as investments rather than consumer goods. Perhaps it is the large dollar amounts involved or the need to finance the expense, but cars are often viewed as more than just an ordinary purchase. Investment can be defined as "putting money into something with the hope of profit." But who is purchasing a new or used car with the expectation of making money down the road? (Pun intended)

Compare a car to a smaller but still sizeable purchase: a new TV. You buy a new flat screen for $3000, watch it for a few years, then either replace it when it goes bad or upgrade. If you are lucky, you might be able to sell it for $500--16% of its original value. Or how about a new smart phone? You pay $200 just to throw it in the garbage after 2 years. These items lose their value much faster and more completely than automobiles. Yet you don't hear people making a big deal about electronics depreciation.

The difference is that the value people gain from new technology is not based on its monetary worth, but rather the entertainment, productivity, and quality of life gains. The latest gadgets make people happy even if they have no resale value.

So let's just try thinking of motor vehicles as big gadgets. Now we can debate the value that is gained in exchange for paying the depreciation:

• Clean Vehicle History
• Perfect Maintenance Record
• New Parts
• Warranty

Reports like CARFAX and AutoCheck will tell you a partial vehicle history including accidents and title information. But these reports will not tell you anything about the maintenance record, oil changes, driving habits, etc. A person could have been drag racing for years while never changing the oil, and you would never know. One of the most significant reasons new vehicle depreciation is so costly is due to there being no way to track the way a vehicle is treated once leaving the lot.

Additionally, the cost of depreciation provides great value with peace of mind. A new motor vehicle comes with shiny new parts, new tires, clean pipes, and most importantly, a warranty. Not only do you have the most reliable pieces to start with, but if anything should go wrong in the first few years, it is fixed at no additional cost to you. And unless you find a used car only a year or two old, you will most likely not receive the factory warranty. Used car dealers themselves might offer warranties as short as 30 days, but private sales will usually have no protections at all.

And the truth of the matter is if you plan to keep your vehicle for more than a few years, the new car depreciation will have very little overall effect. The initial sting of the depreciation is spread out over many years and ultimately won't cause the vehicle to lose much more value than would have been lost by a used car. And if you drive a car into the ground, there are no savings to be gained by buying used to avoid the initial depreciation.

But despite my arguments against overemphasizing depreciation, there are a couple times where it can have a big impact. Fortunately, the car industry offers some helpful products to lessen the potential impact on consumers.

Low Down-Payment Financing

When you finance a new car purchase, there are sometimes opportunities for low or zero down payment loans. These can be great deals, especially when combined with low or no interest rates. The downside to these programs is that immediately when you drive off the lot, you are upside-down on your loan. That is, you owe more than the value of your car.

Being upside-down on loans is troublesome, especially for car loans. There are a lot of factors on the road that you have no control over. And if you were to get into an accident on your way home, even if it wasn't your fault, you would only be covered for the value of the car. That 11% depreciation would come straight from your pocket.

Fortunately, car companies and insurance providers offer something called gap coverage or gap insurance. This product covers the difference between what your insurance pays and the amount of your loan in the event of an accident. This way you will not be out a couple thousand dollars after an accident. And one of the best parts about gap coverage is that despite its price-tag, you can almost always cancel it once you are no longer upside-down on your loan and get a partial refund.

Short-Term Purchases

The other time depreciation might play a major part in your purchase decision is if you only plan to keep the car for 3 years or less. Owning a vehicle for a short period, will cause you to pay a disproportionate amount of depreciation for relatively little value over the short-run.

If you know you won't be holding onto a vehicle for more than a couple years, consider leasing instead. When you lease, you are only paying for the depreciation in value of the car and not all the interest and extra costs. But the buying versus leasing debate is far too complex for this space.

So next time you are looking to buy a new motor vehicle, carefully weigh your options and your finances. But try not to let the dreaded "D" word make the decision for you. Depreciation should be understood, not feared.