Residual Value, Depreciation and Your Used Car
Whether you realize it or not, a vehicle’s residual value should have a large effect on your used car shopping. Everyone knows a brand-new car can lose more than 30 percent of its value in its first year – it’s why smart shoppers buy used – but what about the remaining fraction? What a car retains in worth is called residual value. Understanding how certain factors add or detract from that worth can help you get the absolute most out of your used car both at buying time and when it comes time to send the vehicle on its way.
Residual Value is just the opposite of depreciation. That is, what your car looses in value over time is defined as depreciation and what it retains is called residual value. While these terms are often associated with leasing, they’re just as pivotal to the used-car buying process. So what determines how much a car keeps or looses over time? Loan officers use complex formulas to determine a vehicle’s depreciation based on innumerable factors that decide how much a vehicle looses in a typical year of use. Rather than slog through all of those, let’s take a look at the four most prominent portions of depreciation in no particular order.
Age
Like it or not, every car loses some percentage of its value as time passes. The funny thing is, the amount of that loss changes over time so long as the rest of the factors on our list stay within acceptable parameters. In the first few years, a car stands to lose the largest portion of its value, but by year three the level of depreciation levels off somewhat.
How does that effect your used-car buying? While it’s tempting to jump in on a used model from this or last year to get all of the great tech and advancements manufacturers boast about, those vehicles still have a substantial amount of depreciation to go through. That is, their residual value will continue to plummet after you sign the title. Some buyers may see that as the price you pay for the latest and greatest, but if you aren’t careful, you could wind up owing more on your car loan than the vehicle is actually worth. Not a good spot to be in.
Mileage
In general, anywhere from 10,000 to 30,000 miles is an acceptable amount of mileage for a vehicle to accrue per year. Anything less than that and whatever vehicle you’re interested in will have likely depreciated less than its higher mileage counterpart. Of course, the flip-side of that coin is cars that have amassed more than 30,000 miles per year will be worth less.
Why does mileage matter so much? Every part on a vehicle has a life expectancy, usually measured in terms of miles. The more time a car or truck has spent on the road, the more of that life expectancy has been used up. Even if a car is relatively new, higher miles mean you can expect to replace more parts of the vehicle sooner than its low-mileage brother.
Vehicle Make
This one has as much to do with individual automakers’ performance in terms of reliability and build quality as it does the public’s perception of those attributes. Typically, Japanese and German makes fare better than their domestic counterparts in returning higher residual value. It’s true that by and large, carmakers like Honda, Toyota, BMW and Mercedes-Benz have built their names on high-quality, long-lasting vehicles, and those reputations play a huge role in how much buyers are willing to pay for used versions.
At the same time, General Motors, Ford and Chrysler have all made huge advances in terms of quality and reliability. Unfortunately, those companies’ reputation for building vehicles that don’t last as long as their import counterparts still haunts them today, resulting in lower average residual value. That means if you’re careful, you can find great domestic-made used vehicles with plenty of life left in them for far less than a similar import model.
Vehicle Type
Not too long ago, it was nearly impossible to find a good, used SUV for a smart deal. Now, with last summer’s astronomical gas prices and a new focus on green cars and trucks, driving a big body-on-frame SUV is as unpopular as it is impractical. The result is a surplus of used SUVs and truckish people-movers that would have been the envy of the neighborhood not five years ago. Needless to say, those SUV’s have suffered rapid depreciation due to a change in buyer tastes.
It’s important to keep an eye out for these trends when you’re picking up your next used vehicle. It may be tempting to jump into a particular type of car or truck because of a great deal on the window, but doing so could put you into transportation you can’t easily get rid of when it comes time to upgrade in a few years. If a car or truck has depreciated significantly in a short period of time, you may be better off looking for something else.
Zach Bowman writer for Used Cars
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