How Does Depreciation Affect Claims Payments

Depreciation of automobiles plays a huge role in claims payments in the event of an accident or other loss. Many people do not have a good understanding of depreciation and its role, so they don't properly consider it's impact on their purchase and insurance.

What Is Depreciation?

Assets, or things that we own, either appreciate or depreciate. If the asset appreciates, it increases in value over time. If the assets depreciate, they decrease in value.

Cars are assets that depreciate in value almost exclusively. The only exception to this rule is a few rare vehicles that are in short supply or a small number of classic cars that are highly valued by collectors. Other than that, cars depreciate in value.

In other words, a car is worth less than you paid for it almost immediately after you purchase it.

Buying New Cars and Depreciation

You'll find the greatest amount of depreciation on new cars. These cars have a high price initially, and those who purchase them pay for the 0 mileage, the clean interior, the never-before-driven engine and the new car smell. Many people want to be the first person to drive a car or the first person to own a new car. They want to be free from worries about repairs, about previous damage, and about any hidden accident damage. New cars are great for these reasons. However, you do pay a high price for these benefits.

The instant you purchase a new car and drive it off of the lot, you own a used car. There is no way you could take it back to the dealer--in a few hours, in a few days or in a few months--and get anything close to the same price you paid. That is depreciation. You can expect it to be worth approximately one half of what you paid for it after three years.

Used Cars and Depreciation

Used cars also depreciate steadily. However, the depreciation steadies out over time. The steepest depreciation takes place in the first 3 years. The depreciation steadies out over the next 5 years, where you will lose about half the value again. After 8 years, the depreciation is very small each year.

Depreciation and Auto Insurance Claims

So if you have a new car for which you paid $30,000 and after owning it for 2 years, you are in an accident. You will still owe approximately $26,000 on the car, and possibly more if you took out an extended 6 or 7 year loan.

If the car is a total loss and the insurance company wants to buy you out, they will not give you the $30,000 it cost to buy the car new, and they won't give you the $33,000 it will cost you to go and replace the car with the same model in the current model year.

Instead, they will factor in the depreciation on your vehicle and give you what they determine it was worth at the time you had the accident--which will be approximately $23,000 or less, depending on the mileage and other damage  that the car may have suffered. If it is in absolutely mint condition, then you may get a $23,000 settlement.

Therefore, you not only have to pay off the loan with less than you owe, you will also have to come up with money to replace your car.

Take into account deprecation when you purchase and insure a new car. It may be the difference between financial health and simply not recovering from a loss.