In both accounting and insurance terms, depreciation is a calculation used to help discover the real value of an asset. This is because with specific exceptions most assets lose value over time, in the case of the car this will be through continued use (causing wear and tear on the mechanical parts, weather injury to the outside, gradual fading/abrading of seats, etc.) and the actual fact that newer versions offer better fuel economy, reliability etc. so your car becomes less desirable over time (generally in most instances – this isn’t always accurate particularly for classic cars which might keep their value despite wear and tear).depreciation
Why is depreciation significant?
When you insure your vehicle against damage or loss, your insurer is assuming the danger of replacing your automobile. This doesn’t mean that your insurer will be purchase you a brand new car, when it did your premiums would be vastly more expensive.
But it does suggest that they want to provide you with an equivalent vehicle so you can continue your everyday life.
This means in real terms that an insurer will use depreciation to compute the worth of the benefit paid to you in the occurrence of a claim against your coverage.
How does that function?
For example you could purchase a brand new vehicle that’s worth $50,000 the day you buy this, and also your insurance company might determine that such a vehicle is permitted to depreciate over 10 years.
Which means for each year older the vehicle would lose 1/10th of its own value, in this instance 1/10th of $50,000 is $5,000. That means the maximum benefit they would pay to replace your car is
$25,000. Actually this example is very much over simplified and depreciation calculations for automobiles are a bit more elaborate partly because when you drive your new car home, it loses a big chunk of its sticker price value on the 2nd hand market (and depreciation reflects real-world pricing).
Why does this matter?
Depreciation shouldn’t affect you too much unless you have a car where in actuality the harmony of any finance outstanding on the automobile will cost you much more than the value of your insurance benefit after depreciation. In this situation you must consider gap insurance to make sure you’re not paying for a vehicle that you simply can’t drive anymore.