Car finance: what is negative equity?

Negative equity means you owe more than your car is worth. Find out what you can do about it – wherever you are in your finance contract

Christofer Lloyd
Apr 27, 2020

Car finance can be a great way to get a desirable motor for an affordable monthly payment. However, it could also cost you if you don't understand how it works. Negative equity is one of the things to watch out for with PCP finance and is something you could encounter if you need to hand the car back early - or if it’s stolen or written off.

Negative equity is the situation where the outstanding debt on a car is greater than its current value. This is most likely to be the case at the start or middle of a finance contract, where the car has lost a substantial chunk of value and your payments haven’t covered this amount yet. This happens as cars lose value fastest when new, slowing down as they get older. As monthly payments are fixed, it's not until the end of the contract that the amount you've paid covers the amount of value the car has lost.

    

This isn't a problem if you get to the end of the contract and then hand the car back, however it could be an issue if you return the car early. If you need to hand it back ahead of time - as you’ve unexpectedly had triplets two years into a four-year contract, for instance, and need a larger car or your income’s fallen and you need a cheaper car - you’re likely to be in negative equity.

Look at the table below to see how you can expect to be in negative equity for most of the length of a PCP contract, steadily paying this off with your monthly payments and potentially ending up with some equity - where the car is worth more than the remaining finance balance - at the end of the contract. This isn't guaranteed, but most PCP finance deals are set up so that you should have some equity at the end (provided used car values don't plummet during the contract).

Check out the BuyaCar guide to equity to see how to use equity to your advantage.

Cash price

Value after 1 year

Value after 2 years

Value after 3 years

Optional final payment

£20,000

£15,000

£12,000

£10,000

£9,000

Total amount paid

Value car has lost

Equity

At one year

£3,667

£5,000

-£1,333

At two years

£7,333

£8,000

-£667

At three years

£11,000

£10,000

+£1,000

Negative equity: Gap insurance can protect you

If your car is written off or stolen early on or in the middle of a three-year finance contract, you’re likely to be in negative equity, as the insurance company will pay you back the current value of the car, which is likely to be much less than the remaining finance balance.

This could leave you several thousand pounds out of pocket once the insurance company has paid the current value of the car to the finance company, as relatively new cars could easily have lost far more value than you’ve paid off so far.

This is where 'Gap insurance' comes in. This top-up insurance policy comes in different forms, but effectively covers the negative equity - meaning the difference in this case between the amount the insurer pays you if your car is written off or stolen and the remaining balance you owe the finance company.

Read the BuyaCar guide to GAP insurance, to get your head around the different options available.

Voluntary Termination: a way to hand back a car with negative equity

There is another way to hand back a car on PCP which potentially has negative equity, without incurring additional charges - provided you’ve paid more than half of the total amount owed at the start of the contract: Voluntary Termination.

This is a legal right that allows you to return the car once you’ve paid that amount. Beware though, that using this facility is frowned upon by lenders - and its purpose is to help people avoid financial hardship rather than helping impatient drivers to change car early.

Additionally, using Voluntary Termination multiple times could cause lenders to black list you or charge you higher interest rates in future - as using Voluntary Termination can cost finance companies a substantial amount.

 

Furthermore, you’re only likely to have paid off more than half of the overall balance owed towards the very end of a PCP finance contract - especially if the optional final payment, what the car is expected to be worth at the end of the contract, is particularly high - and at this stage there is a much lower chance of having negative equity.

Negative equity finance: roll negative equity into new finance deal

If your car has negative equity but you need to change it early, fear not. There are ways to roll the remaining debt into a finance deal on a new car. This will increase the overall amount of interest you pay, but could still help you to cut your monthly payments.

If you're looking to use negative equity finance, it's important to understand that rolling your current debt into a new contract and financing that amount again is likely to result in you paying more in interest than if you stuck with the original contract. As a result, the way to make negative equity finance work for you - cutting your monthly payments dramatically - is by choosing a much cheaper car, so that even with the additional interest your monthly payments should be lower.

Visit the BuyaCar guide to negative equity finance to see all your options.

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