How does depreciation affect your car loan decision?

Buying a car might be the second-largest purchase you make in your life, after buying property. But people who take a loan to buy a vehicle often focus only on the interest rate they are charged and the repayments they have to make. They can overlook depreciation.

Here, we’ll explain how depreciation works when it comes to your car or other new vehicle, and why it should be a factor when you are thinking about taking out a car loan.

What is car depreciation?

In simple terms, depreciation is the reduction in value over time. When it comes to cars, it’s the way that their value drops when you drive them off the lot for the first time, and then year by year as time goes on.

Cars depreciate for a few reasons. When they are no longer considered “new”, there’s often a sharp drop in value. It’s been estimated that new cars can lose up to 30 percent of their value in the first year. After that, depreciation tends to occur gradually and consistently as your car ages and you use it.

Wear and tear, along with increased mileage, can reduce your vehicle's value. Buyers often think there’s a higher risk that something will need fixing when a vehicle has a lot of kilometres on the clock. Technological improvements can also mean older cars lose value if they no longer have all the features of newer models.

How fast do cars depreciate in New Zealand?

There can be variation depending on the type of car you have and the market demand for it. In general terms, there is a pattern that is often followed.

First year: The first-year drop is the steepest. When you take your new car home, and it becomes “secondhand” rather than “new”, you can expect its value to drop by up to 30 percent. ConsumerNZ says this is particularly noticeable in New Zealand – our new-car prices are quite high by international standards, so we have more to lose from this initial value drop.

Years two through five: These years have a more gradual decline in value. How quickly it happens depends on the reputation your vehicle has in the market. If it’s known to be very reliable, you might not see as sharp a depreciation as a model with a reputation for being expensive to fix or unreliable.

Very generally, the depreciation might look like this: A new car purchased for $30,000 could be worth $20,000 once the “new car” premium is lost. Then each year it might lose another 15 percent – taking the value down another $3,000 in the first year, then $2,550 the year after and so on.

A $20,000 secondhand car won’t have that initial drop but might lose 15 percent in the first year, taking its value to $17,000, then another 15 percent, taking it to $14,455 and so on.

Reductions still happen most quickly, in dollar terms, at the start and then taper off. It generally takes a long time for a car to be worth nothing.

What might influence the rate of depreciation?

There are a few things that can be factors in how fast the car depreciates:

• The brand: Is it known to be reliable and sought-after? Or will people view it as risky and expensive?
• The type of vehicle: SUVs, hatchbacks, electric vehicles and utes can all depreciate at different rates.
• Mileage and condition: A car with high mileage will depreciate faster than one that isn’t driven much, even if they are the same age. If the car is looking battered, it will also lose value.
• Fuel type and cost to run: During periods when fuel is expensive or when people are concerned about environmental impact, vehicles with a reputation for being “gas guzzlers” may be less valuable.

Why does depreciation matter for your car loan?

There are a couple of reasons why depreciation can be important to consider when you are taking a car loan.

Loans are based on the purchase price, not the future value of your car. You may need to be prepared for the possibility of owing more on your car than it is worth at certain points during the loan term. That is not a problem if you are happily using your vehicle, but it could become an issue if you needed to sell while you were in that position.

If you know you plan to sell or upgrade your vehicle within a certain period of time, and you think the car might have dropped below your loan balance, you may need to consider how to address that. Could you pay down your loan more quickly? Or are you prepared to borrow more on the next vehicle to pay off the loan and purchase your next vehicle, too?

What do you need to know about negative equity?

Negative equity refers to any situation where the asset you’ve bought, whether that is a house or a car, is worth less than the loan it secures. With vehicle loans, it happens most often in a few scenarios:

If you bought a new car for $30,000 a year ago, for example, and had borrowed the full amount with a 15.99 percent interest loan over five years, in the first year you would reduce your balance by just under $4,000. But the value of your car could drop by $10,000.

New car versus used car: The depreciation trade-off

Here are some points to keep in mind if you’re weighing up your decision.

New cars

• New cars depreciate faster in the early years as they move from being “new” to being secondhand.
• You may also need to borrow more to purchase them, increasing the risk of negative equity.

Used cars

• Used cars tend to depreciate more slowly.
• They can offer better value to first-time or budget-conscious buyers.
• It may be possible to buy almost-new vehicles at a lower price than new.

Buying new makes sense for some buyers; for example, those who value the warranty they might get with their purchase, prefer full control over servicing and care, or plan to own it for a long time.

Why does loan structure matter when it comes to depreciation risk?

Some loan structures can increase your risk of depreciation, putting you into negative equity.

Long loan terms: If your loan term is stretching out to five or seven years, you’ll be paying off your principal more slowly, creating more opportunity for your car to depreciate faster than your loan balance is coming down.

Low or zero-deposit loans: If you only have a small deposit, or don’t have one at all, you’ll need a bigger loan.

Balloon payment structures: Balloon payment loan structures mean you don’t pay a portion of your loan until the end of the term. This means your loan balance does not decrease as quickly. If you're interested in how different methods can help you repay your loans, you may want to read about Avalanches and Snowballs: Strategies to Pay Off Debt.

Other costs added to the loan: If you’ve borrowed more than the cost of the car, you’ll end up owing more money. That might include warranties or insurance added to the finance.

How to factor depreciation into your car loan decision?

If you’re concerned, there are steps you can take.

Choose a car that holds its value: A reliable, trusted brand with a long lifespan could be an option.

Consider your loan term: If you’re able to keep your loan term shorter, you’ll pay down your debt more quickly.

Limit your borrowing: Consider what your car is likely to be worth over the term of your car loan, and whether you could borrow an amount that matches that value rather than the full purchase price.

Extra repayments: Your lender may allow you to make extra repayments to reduce your loan balance. We can help you determine what fees might be associated with this.

How to reduce the impact of depreciation?

You might be able to reduce the impact in a few ways.

How does depreciation affect different buyers and borrower types?

First-time buyers: They often purchase more affordable cars, which may limit depreciation. Still, they may want to structure their loan to ensure it declines at least as quickly as the car's value declines.

Families upgrading vehicles: If you’re upgrading your vehicle and there’s a risk you may owe more than your existing car is worth, you may need to speak with a lender about how to structure the loan for your new purchase. We can help with this.

Self-employed or business buyers: Depreciation will be taken into account in your end-of-year tax return. As long as you paid more than $1,000, you will be able to claim depreciation. You can claim depreciation only on the business-use portion of your vehicle’s value, and depreciation rates vary. Your accountant or bookkeeper will be able to advise you.

People planning to upgrade regularly: If you know you’re going to want a new vehicle every two or three years, you’ll need to plan your loans to substantially reduce your balance over that period, so you aren’t always rolling one loan into the next and increasing your balance owed, and paying more in interest.

FAQ

How much does a car typically depreciate each year in New Zealand?

It can vary a lot depending on the type of car. In general, they can depreciate up to 30 percent in the first year and then potentially 15percent each year after that.

Do electric vehicles depreciate faster than petrol cars?

They can do so, particularly if there have been advances in technology.

Can depreciation affect my ability to refinance a car loan?

If you owe more on your car than it's worth, you may need to consider your options before refinancing. We can help you work through this.

Is depreciation worse with a balloon payment loan?

Because balloon payment structures save a large part of the repayment until the end of the loan term, it can increase the risk that you end up with negative equity before the end of the loan term.

Should I always choose a shorter loan term to avoid the risk of negative equity due to depreciation?

You should choose the right loan term for your individual circumstances. Depreciation may be a factor, but it won’t be the full picture. We can help you determine which solution is appropriate.

Want to talk vehicle lending?

The team at better finance™ are lending professionals and are here to help with whatever questions you may have. Whether you’re buying your first car or refinancing your 10^th, we can help you find the right loan for your situation.