Car Finance with Negative Equity
When a car slips into negative equity while on finance, it can cause issues. Find out what exactly this means and how to minimize any problems with CarMoney.
Negative equity is a concept that normally relates to property – falls in house prices can leave owners in a position where they owe more on their mortgage than their home is currently worth. This issue can, for example, present difficulties for anyone who’s thinking about selling a financed car.
What is Negative Equity?
For car finance customers, being in negative equity means that the amount they presently owe to the finance company for the vehicle is greater than the current value of that vehicle. This situation isn’t as rare as you might think, especially when brand-new models are involved.
Depreciation in a car’s value is typically sharpest in the first weeks and months immediately after it’s sold. What usually happens is that the rate of depreciation slows while the loan is repaid at a constant rate, leaving the borrower eventually in positive equity.
Some forms of finance – PCP (personal contract purchase) in particular – can make the negative equity calculation more complicated. Customers at the end of their PCP term generally face an optional one-off payment – known as a balloon payment – which can be made in order to purchase the vehicle outright. If at the end of the PCP term, the vehicle is worth more than the balloon payment figure, there is positive equity available. Here the customer has a choice: they can either make the balloon payment to buy the car or use the equity as a deposit on a new PCP deal.
How do I work out if I have positive/negative equity on my car?
A common question we get asked! There are a few steps you will need to take in order to work this out:
- Find out the value of your car with any valuation tool. All you will need is your registration.
- Ask for a settlement figure from your current lender.
- Next, time for a tiny bit of maths, subtract the settlement figure from your car’s valuation price. This will equal the amount of equity available in your car. If you have a positive figure, great news! You can use this amount of money as a part exchange for your next car. However, if the figure is negative, you’ll need to pay that amount of money on top of your new car’s price.
If the vehicle is worth less than the balloon payment because it has depreciated to a greater extent than expected, they’re in negative equity. This means they don’t have any equity to roll over on to a new PCP loan. There’s still the option of making the balloon payment, but the customer can also choose simply to walk away and hand the car back to the finance company.
Negative equity and Hire Purchase (HP)
Negative equity is less of a problem for cars on Hire Purchase finance because the monthly payments are higher, which means that you pay off the balance quicker – and automatically own the car once you’ve made the last monthly payment – and so the remaining debt is less likely to exceed the car’s value.
However, if you do find yourself in negative equity early on in the contract and need to cancel your Hire Purchase contract, then you should be able to take out finance on a cheaper car, as part of a plan that will also allow you to spread the cost of the remaining balance and any fees on your previous vehicle.
Negative equity and Personal Contract Purchase (PCP)
Most negative equity finance is used to help pay the early settlement fees on PCP agreements, which offer low monthly payments and a range of options (including returning or buying the car by making the large optional final payment) at the end of the contract.
Once you’ve found a replacement new or used car, you need to arrange negative equity finance. You’ll then have your current car collected. Your outstanding finance will then be settled by the new finance provider and you’ll then make one monthly payment to the new lender, which covers the finance for your new car, as well as any outstanding balance and/or fees owed from your previous contract.
If you’re struggling to make repayments on your vehicle, it could be worth getting in touch with your finance provider to see if they’d be willing to restructure your loan – perhaps over a longer period – to make it more affordable. This applies whether you’re in negative equity or not.
So to sum up, what are your choices if your car finance deal has left you in negative equity?
Do nothing. If you can still afford your monthly repayments and are happy with your car, there’s no need to act. The terms of your loan will remain the same until it’s cleared.
Sell or trade-in your car and make up any difference between the sale price and the outstanding finance out of your own pocket.
Trade-in your car for a cheaper model and seek negative equity finance – which covers the gap between the outstanding loan and the trade-in price, as well as the cost of the new vehicle.
Apply for voluntary termination, provided you’ve paid at least half of the total finance package and are prepared simply to hand the vehicle back.
Your contract may have a clause called ‘voluntary termination’. This means you can hand the car back and not make any additional payments, as long as you’ve paid at least 50% of the total cost. Voluntary termination shouldn’t affect your credit rating, so long as you have kept up repayments.