Negative equity is something that is historically related to property and mortgages. It refers to the circumstance where the value of the item, in that case, a house, has dropped below the amount that’s owed by the buyer. In recent years, with the growing popularity of car finance, negative equity is now something that often comes up when buying a car.
With the nature of a car’s value, and how it can drop when you drive it off the sales forecourt, negative equity is something that must be considered whenever you’re entering into a car finance deal. While this drop in value may not place you in a position of negative equity, it may happen over time. You’ll need to work out how it may affect you and whether there’s anything coming up that could change your circumstances and the need for the car that you currently have or your ability to pay for your finance deal.
What is negative equity car finance?
When you buy a car, whether it’s new or used, its value will change during the course of your ownership. Negative equity in car finance is when the car is worth less in real terms than you currently owe for the remainder of your car finance term. This will be down to the street value of the car dropping during the course of the finance deal.
A car’s value generally drops fairly quickly once it has been bought, especially with new cars, and at this point, it’s likely that the value of the car will drop below the amount that you owe, especially as you’ll still owe most of the amount. In many cases, this will even out over the course of the finance deal and not be an issue, and should usually leave you in positive equity come the end of the term. The issue with negative equity will generally come about if you need to trade your car in or sell your car during your agreement, perhaps due to an unexpected change in circumstances.
You can seek negative equity finance by trading in your car for a cheaper model. This will cover the price gap between the outstanding amount you owe, the price you get for trading in your car and the finance costs of a new vehicle. This is something you may need to consider if you can’t afford to make your current repayments or you’ve been hit by large excess mileage or damage penalties.
When is negative equity a problem?
Negative equity in car finance deals can become a problem when a borrower’s circumstances change suddenly and they need to either sell their car or try and part-exchange it for something smaller or larger. This could happen for a number of reasons, they may suddenly need a bigger car as their family grows, or they may need something smaller if they have to move into a city for work.
There’s also a chance that an accident, writing your car off, going over your mileage allowance, theft of the car or causing repairs that go beyond general wear & tear can cause problems with negative equity.
At this point, partway through a car finance term, there’s a good chance that the car’s value is lower than the amount they have left to pay on their deal. If you are trying to do this then you’d need to pay off the remaining balance, but if the car is worth less than you currently owe, you’d also have to make up that difference from your own finances.
Negative equity works in slightly different ways depending on the type of car finance deal that’s been used to finance a car.
Negative equity with PCP
Personal Contract Purchase is the most common type of car finance for negative equity to become a factor. As repayment rates are generally quite low, the value of the car can drop below the amount you owe quite quickly. This means that if you need to trade your car in for another one for any reason, and its value has dropped below the amount you owe, you’ll have to work out a new negative equity finance deal, that pays off the outstanding amount, plus the difference between the values.
With a PCP deal, negative equity can also come into play at the end of the term. At the end of a PCP deal, you’ll generally have the option of paying a balloon payment to own the car outright. There are two circumstances that can happen here:
- The car is worth more than the balloon payment - the borrower is in a position where they have positive equity.
- The vehicle is worth less than the balloon payment - the borrower is in a position where they have negative equity.
If the borrower finds themselves in a position where they have positive equity, they can either just buy the car outright or use that positive equity to go towards the deposit for a new car with a new car finance deal. You can always return the car and walk away, but being in a position of positive equity can be advantageous.
If you are in a position of negative equity, there’s nothing to roll over to use as a deposit, so your options are to pay the balloon payment and own the car outright, or return it and walk away.
Negative equity finance is often used to help pay for any early settlement fees that come up when an individual decides to terminate a PCP agreement before the end of the agreed term. This negative equity finance will then form part of your ongoing car finance deal on a new car.
It’s also worth taking into account any outstanding excess mileage or damage fees when looking at the above situations. If these fees are particularly high it could leave you in a position of negative equity. If you can’t afford to pay them, you may be able to roll those fees into a negative equity finance deal on your next car finance deal.
Negative equity with HP
When buying a car with a hire purchase agreement, negative equity can be much less of a problem. The repayment amounts are generally higher, and the car is automatically owned outright come the end of the term. Both of these combined make negative equity less common for an HP deal.
The higher repayments mean you generally keep up with the depreciation of the car’s value and don’t owe more than the value of the car after a short initial period. Plus, as these deals are designed for the borrower to own the car, they are less likely to want to return it either at the end or during the term of the agreement.
This doesn’t mean that negative equity with HP deals doesn’t happen. If the car needs to be returned the borrower may need to organise a repayment plan with a new car finance deal for a cheaper car.
Negative equity with PCH
PCH can be slightly more complex when it comes to negative equity. Whether you can end the agreement early comes down to your individual agreement, sometimes there may be a large fee involved or else you may simply be unable to.
As the car is being leased, you won’t own it at the end of the agreement, but you may find yourself with high penalties if you’ve exceeded the mileage or returned the car in bad condition. If you can’t afford these fees you may be able to negotiate a negative equity finance deal for your next vehicle bought on car finance.
How to get out of negative equity car finance?
If you are in a situation where you are in negative equity but need to return the car or get out of the car finance deal, there are a number of options available to you.
- Settle the loan - If you want to leave an agreement early you may be able to settle your loan. This means paying up what you owe or meeting any settlement fees that are in the contract. This can often end up being more expensive, but you may be able to roll this into a negative equity finance deal for your next car.
- Continue paying - If you are in negative equity, but can afford to make your repayments, one option is to simply do nothing. Being in negative equity early on in a car finance deal is not unusual and it may well even itself out, or even turn into positive equity if you’re on a PCP deal. Don’t panic too much if you see your car’s value plummet, as it’s mainly if you need to return your car that the problems may arise.
- Voluntary termination - Many ar finance deals have voluntary termination policies baked into them. If you want to leave your car finance deal early, you should check your contract. Some deals allow you to return your car and walk away if you’ve paid at least half of the agreement off.
If you find yourself unable to meet your repayments or are worried about entering a situation of negative equity on your deal, it’s always worth talking to your lender to see whether they can assist with restructuring your current repayment plan. They may be able to help by spreading it out over a longer period with smaller repayments or look at other options with you. Being upfront with your lender may help you avoid a sticky situation.
Can I part exchange a car with negative equity
For some car finance deals, like PCP, you may be in a situation where you can trade your car in for a cheaper model. If you do this you may be able to seek negative equity finance with your lender to cover the gap between the two cars.
Negative equity finance will allow you to pay for the new, cheaper, car and continue paying off your agreement each month. The agreement will take into account the cost of the car you are now paying for, but also the amount you owed from your previous deal and the negative equity involved in that. This may be an option if you have a sudden change of circumstances or can’t afford to pay for your current car finance deal.
How to finance negative equity on a car
If you find yourself in a position where you have negative equity and have had to trade your car in for a new cheaper model, or you’re there because you’ve got excessive mileage or damage penalties, you may be able to enter a negative equity car finance deal.
To do this you’ll need to do something along the lines of:
- Find another model of car that’s less expensive than your current model’s value
- Trade-in your current car and use that to get a new car finance deal - this should be aimed at having lower monthly payments
- Agree with the lender the additional fees to be added to cover the negative equity from your previous agreement
You are essentially refinancing your car, and as such will be entering a whole new car finance deal that’s designed to pay off both your new car and the negative equity from your previous agreement. To work out what you can afford we’d recommend trying out our car finance calculator.
How to avoid negative equity in the future?
Avoiding negative equity on a new or future deal is a good thing to work towards and, while it’s sometimes impossible to know how much a car will depreciate, there are a few ways you can avoid negative equity.
- Put down a bigger deposit - a general rule of thumb with car finance is that a bigger deposit is better anyway. It’ll help you keep down monthly costs, but it also means the amount you are borrowing is reduced, which means you’re more likely to owe less than the depreciated value of the car.
- Buy a used car - used cars generally fall in value slower than a completely new car. New cars depreciate dramatically when they are first bought, but a used car doesn’t have this issue as its value is likely to have stabilised since its initial drop off. This is why a used car finance deal can be an excellent way of avoiding negative equity.