Learning to drive a car safely is not enough if you want to drive legally. It is mandatory in every state of the US to have some form of auto insurance coverage to legally operate any road vehicle. With over 6 million passenger car accidents happening every year, it is a no-brainer why the insurance market is rising spectacularly.
Auto insurance rates are like the weather; never the same for everyone, great for some people while terrible for others. The entire auto insurance market is heavily affected by multiple factors which cause price shifts. One such factor is depreciation and it can impact your auto insurance premiums. There’s a side to it that you might like and a side that you won’t. Here’s everything you need to know about the impact of depreciation on your auto insurance policy and insurance premiums.
Understanding Depreciation
Most of the things that we buy today lose their value with time. The same is true for cars. No matter how expensive your car is at the time of buying it, it will lose its value over time. The first year causes the most depreciation, and then the price goes down steadily for the next few years. Depreciation is calculated by subtracting the current sale price of the car from the purchase price. The difference is how much the value has been depreciated.
Cars usually lose almost 20% of their value in the first year alone. Many other factors can affect the pace of depreciation. Some cars lose more value than others. This depreciation affects your auto insurance rates. Now let’s look at how.
Depreciation and Auto Insurance
When you get yourself auto insurance, the car registered to your name gets the coverage. You can add more cars if you want to, and you’ll have to pay extra for their coverage. Auto insurance rates are decided by taking in multiple factors. We’ll list the relevant factors for this topic.
The cost of your car, the make, model and other factors of the car decides the price of your auto insurance and the premium. Collision coverage and comprehensive coverage are the two most popular policies that consider depreciation as one of the most impactful factors in deciding insurance premiums.
Collision Insurance: A collision insurance policy covers your car from accidental damage regardless of whose fault the accident was. If the accident was your fault, you can use collision insurance to pay for the repairs. If the accident was not your fault, and the liability coverage of the other driver is not adequate, you can still use your collision insurance coverage to pay for what’s needed.
Collision insurance coverage is essential to have because it provides excellent coverage against accidents, and road accidents are as common as seeing cars on the roads. But this insurance policy can be expensive, so try to compare the prices of different policies and get the best cheap auto insurance on the market.
Comprehensive coverage: Comprehensive insurance covers all the damages to your car that may happen due to natural calamities. These natural calamities include floods, earthquakes, fires, hailstorms, etc. It also covers damages due to riots, vandalism, theft, etc.
The reason why these two auto insurance coverage is relevant to this topic is that both of these policies offer a total loss payout. This means that in case your car is beyond repairable, these policies will give out the total cash value of your car.
But the actual cash value (ACV) is different from the MSRP, or the price that you paid when you got the car. The ACV represents the current value of the car which is determined by multiple factors such as the condition of the car, the mileage on it, the condition the car, and the market demand for it. The insurance company decides the ACV of the car.
How Depreciation Impacts Premiums
Your insurance coverage, or the total amount of money you can claim in case of total loss changes every year. Since the value of the car decreases, so does the ACV. There’s something positive and negative about this.
For example, since the current market value of the car decreases, you’ll pay a lower premium than what you were paying when the car was brand new. This also depends on the car insurance company as each company has its own set of rules and policies. But generally, as the value of the car depreciates, the premium rates will go down as well. While it seems good at first, there is one big problem here.
The price of your car is going down. So if you bought your car for $40,000, due to depreciation and the insurance company’s estimate, the actual cash value of your car could be $15,000 or even lower. So in case of a total loss, you’ll only get a fraction of what the car cost you (minus the deductibles). This can pose a bigger problem that is not obvious at first.
Imagine what would happen if you bought your car on a loan. The MSRP of the car is $40,000, but since you are taking it on a loan, the total amount owed to the bank is $55,000 for 5 years. What happens if you total your car? Sure you have insurance that will pay for the actual value of the car. But here’s the catch, it won’t pay the entire amount.
The best-case scenario would be that the insurance would pay the entire $40,000. It is rare, but it could happen. But you owe the bank $15,000 more. That will come out of your pocket. This is why Gap insurance policies exist and you should get them to offset depreciation and loan repayment risks.
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