Negative equity in car finance explained

September 07, 2022 by

Concerned about negative equity with cars? Our guide has all the details

Negative equity is most commonly associated with houses, where the value of a home is less than the amount owed against it on your mortgage. This is both an uncomfortable idea, and can cause difficulties if you wish to sell your house.

When it comes to cars, negative equity is far less likely to happen, but there are some specific circumstances where it could occur. Here, we detail what these are, and what you can do to avoid them.

Why is negative equity car finance rare?

In the main, negative equity is not a significant issue where new-car finance is concerned. ​​This is because the vast majority of privately owned new cars are obtained via Personal Contract Purchase (PCP), which sets a guaranteed minimum future value (GMFV) that the car will be worth at the end of the finance period.

This means it is contractually impossible to be left in negative equity if you adhere to the terms of the deal.

A PCP deal comprises three parts: the deposit, the monthly repayments and the final, optional ‘balloon’ payment that comes at the end of the deal.

The deposit and the monthly repayments you make during a PCP contract pay off the depreciation the car experiences over the course of the deal.

At the end of the deal, the final balloon payment is based on the car’s GMFV, which is predicted based on historic trends and the type of car in question.

It is possible that the car will be worth less than the GMFV at the end of the deal. However, because that figure is contractually set, any shortfall in the car’s value – negative equity – is the responsibility of the finance provider, not you.

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As an example, let’s say you choose a car costing £30,000 on a 0% interest PCP deal that runs over four years.

You put a £5,000 deposit down, and the car’s GMFV is set at £10,000 – that’s the minimum amount the finance company and you agree the car will be worth after four years. After the deposit, that leaves you paying £15,000 in monthly repayments over four years, which works out at £312.50 a month.

If the car is worth more than the GMFV – let’s say £12,000 – after four years, you have £2,000 ‘equity’ in the car. It’s not really equity, though – it’s actually that you have paid off more than the car has depreciated. If this happens, you can use the £2,000 to go towards the deposit of a new car, if you stick with the same finance company – although you can’t take this amount as cash if you decide to walk away.

If the car is only worth £8,000, the car is technically in negative equity – but this is not your problem, it is the finance company’s. This does mean, however, that you won’t have any overpayments (AKA equity) to help towards a new car on another PCP deal.

So how does negative equity happen?

Depreciation tends to hit cars hardest in the early months, with vehicles losing value as soon as they are driven away from the showroom. That depreciation curve becomes more gentle as time goes on, but there may be a period of time when the amount you owe on the vehicle is more than it is worth.

This means PCP customers may be technically in negative equity for some periods of their contracts, but by the time the end of the contract comes around, things have balanced themselves out (and as discussed earlier, even if this hasn’t happened, any shortfall in GMFV is the finance company’s problem, not yours).

Negative equity and GAP insurance

If your car is stolen or written off for any reason, you may find that the market value paid out by the insurance company for the car is less than the amount still owing to the finance company – and it’s still your responsibility to pay the finance company what is owed.

If this happens, you will effectively be in negative equity, and there isn’t much you can do to mitigate this after it’s happened.

GAP (Guaranteed Asset Protection) insurance will make up any shortfall between what the insurance company pays out and what is owing to the finance company. Our guide to GAP insurance has more details.

Interested? Carwow is proud to partner with MotorEasy for GAP insurance. Simply enter your reg plate and a few details about your car and get an instant quote. And as a special offer for Carwow customers, MotorEasy is giving 15% off its GAP insurance.

Negative equity and selling a car

If you need to sell a car mid-way through your finance contract, there’s a chance it is worth less than the amount owing on it. As you will need to settle any finance in order to sell the car, this may lead you facing negative equity, which you will need to settle yourself before the car is sold.

Bear in mind, though, that almost all finance agreements for cars involve the finance company, rather than you, owning the car until the contract is completed, so be sure to speak to the firm before entering into any discussions relating to the sale of the vehicle.

Negative equity and early exit

If your personal circumstances change and you are left unable to afford the monthly repayments on a car, you may wish to exit a finance contract early. The Consumer Credit Act allows you to do this without penalty if you have paid off 50% or more of the total finance amount (including fees, interest and the balloon payment).

If you have not paid off 50% of the finance agreement and wish to exit the contract, you may find that the amount you owe is more than the value of the car. If this is the case, you will have to make up the difference out of your own pocket, experiencing the effects of negative equity as you do so.

It is possible to consolidate this into a new loan using a specialist negative equity finance provider, although interest rates with these types of loans can be high.

Negative equity and Hire Purchase

This guide has so far been about PCP contracts as these are the most common type of finance used to purchase cars, but there also exists Hire Purchase, where instead of paying off the car’s depreciation, you are renting the car, with your monthly repayments seeing you own it at the end of the contract, with no balloon payment at the end – when the contract is finished, you will own the car outright.

If you need to exit a Hire Purchase agreement early, the 50% rule set out by the Consumer Credit Act also applies, allowing you to hand the car back without penalty if you have paid this amount. The flip-side to this is that if you haven’t paid off more than 50% of the agreed finance, not only will you have to give the car back, but you will also have to make up any shortfall to settle the contract. This may not technically be negative equity, but it arguably may feel like it.

Change cars with Carwow

Looking for an easy way to change your car? Then Carwow is the place to go. You can sell your car online for a great price, and get the best deals on a new one. All through our network of trusted dealers and all from the comfort of your home. Tap the button below to get started today.