The Impact of Depreciation on Your Car Loan

There's a well-known saying that a new vehicle loses value the second it leaves the dealership lot – and it’s not far from the truth. According to Edmunds, the average $30,000 sedan depreciates by nearly $6,000 in its first year of ownership and loses more than half of its original value by the fourth year. Depreciation can make reselling your vehicle a challenge, and it can also have a significant impact on your auto loan.

Definition of Depreciation

Depreciation varies for each vehicle, but it typically starts with a sharp initial drop followed by a slower, more gradual decline. As CarsDirect points out, unless you purchase a vehicle well below market value, your new car will be worth less than you paid for it shortly after you begin driving it. Depreciation can also be influenced by factors like supply and demand. For example, if you purchase a rare or limited-edition vehicle, you may be able to resell it for a profit if there’s strong demand in the market.

Turning Upside Down

Because depreciation occurs quickly at first, driving your vehicle for a few years and selling it at market value could leave you “upside down” on your auto loan. Since your loan payments are likely lower than the initial depreciation, you could owe more than the car is worth if you decide to sell. In this situation, you would have to pay the difference out of pocket, which could create financial strain if you're planning a down payment on a new vehicle.

Methods of Avoiding the Flip

To avoid going upside down on your auto loan, NADA Guides recommends paying at least 20 percent of a vehicle's price as a down payment. By doing so, you’ll borrow less from your lender, pay less in interest over the life of the loan, and likely have lower monthly payments. This down payment will also help protect you against depreciation, potentially offsetting much of the value loss in the first year.

Kelley Blue Book also suggests considering a used or certified pre-owned vehicle. A gently used car from the previous year could cost 20 percent less than a new one while offering many of the same advanced features. Since much of the depreciation has already occurred, you'll have a better chance of staying ahead on your loan and could even break even if you decide to sell later.

Depreciation is a certainty for nearly every vehicle in the first few years of ownership, but going upside down on your car loan doesn’t have to be. With a larger down payment or by considering a pre-owned vehicle, you’ll be in a better position to keep your finances on track.