What Is the Rule of Thumb for Auto Depreciation?

Depreciation is the allocation of a long-term asset's cost over its useful life. Examples of long-term assets include buildings, computers, equipment and cars. The value at the end of a car's useful life is known as its residual value or salvage value. Car buyers should be aware of the effects of depreciation on new and used car values over time, especially when negotiating a fair price with a dealer.

Facts

Edmunds, an information company for new and used cars, suggests that a new car loses about 11 percent of its value as soon as it leaves the dealership. In the first five years, which is generally the useful life of a new car, the depreciation rate is 15 to 25 percent per year. A new car is worth about 37 percent of the purchase price after five years. According to these general rules of thumb, a new car purchased for $10,000 is worth about $8,900 [$10,000 x (1 - 0.11) = $10,000 x 0.89 = $8,900] the minute it leaves the dealership and about $3,700 ($10,000 x 0.37) after five years.

Significance

Depreciation has no impact on a buying decision if the objective is to use the car as long as possible. However, as Edmunds notes, depreciation rates matter if the plan is to trade in the car every few years for newer models. Depreciation rates vary. For example, a Ford is likely to depreciate faster than a Lexus or a BMW.

Calculations

Online car retailer CarsDirect suggests a way to estimate used car costs, including using applicable sales and use taxes. First, the selling price should be determined using Edmunds, Kelley Blue Book and other sources for manufacturer's suggested retail prices. Second, the residual value after annual depreciation expenses should be calculated. CarsDirect suggests using the midpoint of a 15 to 18 percent range for the depreciation rate, which is about 16.5 percent. Third, the taxes can be estimated on this residual value.

For example, if a car was purchased for $20,000 two years ago, its residual value after years one and two are $16,700 [$20,000 x (1 - 0.165) = $16,700] and about $13,945 [$16,700 x (1 - 0.165) = $13,944.50], respectively. The buyer can then estimate the sales, use and other taxes on this residual value. It is only an estimate, because taxes are based on the actual selling price, which might be different from the residual value.

Tips

According to Bankrate's Lucy Lazarony, buyers should consult Edmunds, Autosite or other resources for up-to-date pricing information on new and used cars. This information should be used as a guide because actual prices depend on several factors, such as supply and demand, repair history, mileage and overall condition.