The term , depreciation, as it relates to car leasing and buying, refers to the loss — depreciation — of value as a car gets older. All vehicles suffer from loss of value from the time they are driven off the dealer’s lot. An average vehicle will lose half of its original MSRP value in 3 years. The highest depreciation is during the first couple of years, then it slows every year after.

The reason that leasing offers significantly lower monthly payments than buying with a loan is that, with leasing, only the depreciated value is financed, not the entire value of the vehicle. Roughly speaking, if  a car’s value depreciates by 50% in 3 years, a 3 year lease will have monthly payments of about 50% of loan payments for the same car, same term, same finance rate.

An average new car will depreciate in value by about 27% of MSRP in its first year, 12% more (39% total) in its second year, 11% more (50% total) in its third year, 9% more in the fourth year (59% total), and 7% more (66% total) in its fifth year.

Every car is different in that some makes and models depreciate more than others. For example, Honda vehicle values depreciate slower than, say, Jeep. Generally, vehicle that are in high demand, have excellent reliability and quality, and maintain high resale values will suffer the least depreciation.  This make them good buys and excellent leases.

Depreciation is one of the unavoidable aspects of car ownership and every car owners suffers it, whether they buy new or used. New cars suffer more but eventually all car owners experience a loss — assuming they sell or trade their vehicle, or if their vehicle is totaled in an accident.

Of course, depreciation increases for vehicles with higher than average mileage, accident damage, unrepaired problems, vehicles with reported reliability issues, or a history of recalls.

For example, at the time of this writing, Volkswagen diesel vehicles have been discovered to have been purposely altered to misreport emission levels during testing. The value of those vehicles, unfortunately for owners, has plummeted to practically nothing — depreciation at its worst. Fortunately, those who leased those vehicles are protected by their guaranteed lease-end residual value. They’ll simply return the vehicles at the end of their lease, walk away, and VW takes the huge financial hit.

Here’s a video that explain how new car depreciation works: