Negative Equity on Car Finance: What You Need to Know

What Is Negative Equity in Car Finance?

Negative equity happens when the loan amount you owe from a car finance deal is more than the current value of your vehicle. This can happen with contract purchase, personal contract purchase (PCP), Hire Purchase (HP), or any auto loan. You may see it if the value of your vehicle goes down faster than the loan balance you are paying off.

For example:

If you sell the car at its market value, you will still have to pay £3,000 more to the finance provider. This extra amount is known as negative equity. A lot of people in the UK deal with this problem.

Why Negative Equity Happens

1. Rapid depreciation – A new car loses value fast. It can drop by 15–35% in the first year. By year three, it may be worth only half. Luxury cars or the newest models may lose value even faster.
2. Low or no significant down payment – If you put little money down, you have to borrow more for the car. You end up owing a big part of the price from the start.
3. Long loan term – A long loan term, like 5–7 years, helps keep the monthly payments low. But it will take more time for you to have positive equity in the new car.
4. Balloon payment structures – A PCP agreement usually ends with a big final balloon payment. Most of the small payments you make are for the loss from rapid depreciation and not for building up positive equity in the car.
5. Market shifts – The car’s value can go down even faster because of things like supply chain problems, higher prices for fuel, or less demand from people buying cars. These things can lower your car’s value quickly.

How Does Negative Equity Affect Your Financial Situation?

Negative equity can give you less choice. It can also make you worry more about money.

Reduced Flexibility

If you want a new car or wish to get a new car loan, you must first pay off the settlement figure. This is what you owe as the remaining balance on your loan. Most of the time, you have to clear this amount before you can get a new car loan or a new vehicle.

Financial Implications

• Trade-in limitations – If your old car has a lower value than what you still owe, the dealer may ask you to add the difference to the new finance agreement when you make a trade-in.
• Higher future payments – If you add negative equity to a new loan, the loan amount will go up. This will make your car payments higher.
• Cases of financial hardship – A job loss, sickness, or a drop in your credit score can make things tougher. If you try to sell the car, you may still end up with some debt left to pay.
• Refinancing challenges – If you have negative equity, lenders may not let you get a lower interest rate.
• Insurance gaps – If something happens to your car and it is totalled, the insurance company only pays the market value. They do not pay the whole loan balance, so you may still owe money.

How to Check If You’re in Negative Equity

1. Find Your Current Loan Balance

Ask your finance provider for a settlement figure. A settlement figure tells you how much you need to pay to end your finance agreement. This amount may include early settlement fees, as the Consumer Credit Act allows.

2. Find the Current Value of Your Vehicle

Use trusted tools like CAP or Glass’s, or other ones that many people in the industry use, to find out how much your car is worth. You can also talk to dealers to get a part-exchange valuation. This will help you have a good idea of the price if you plan to trade in your car. The prices you see in car listings are mostly higher than what you will get when you sell or trade in your car.

3. Compare the Two

If the loan amount is higher than what your car is worth, you have negative equity. A negative equity situation can happen when the value of your vehicle is less than what you still owe. If you try to sell it, you will need to pay the difference.

Can You Trade In a Car with Negative Equity?

Yes, but you have to deal with the shortfall.

1. Rolling over the debt – You add the remaining debt into your new finance agreement.
   For example, if you still owe £3,000 more than the value of your vehicle, the dealer adds that £3,000 to the price of your new car. This makes your loan term longer, and your monthly payments will go up.
2. Paying the shortfall upfront – If you have some money saved or can give a significant down payment, you can pay the shortfall now. This clears the debt in one go, and you get a new start.
3. Waiting it out – You keep up with the loan payments until the value of your vehicle is more than the loan balance.

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Options for Dealing with Negative Equity

Continue Your Current Car Payments

Staying in your agreement until the end of the contract can help you avoid more debt in a new deal. This gives you more time for the remaining balance to go down. By then, your car’s value might be higher than what you still owe.

Voluntary Termination

Under the Consumer Credit Act, you have the right to return your vehicle when you pay half of what you owe for it. The amount will also include the final balloon payment if you have a PCP plan. Many people do this in cases of financial hardship.

Make Extra Payments

Putting extra payments on your loan brings the amount you owe down. This helps you reach positive equity faster. It also lowers the interest you have to pay.

Refinancing for Better Terms

If your credit score has gone up, you can look for a new finance agreement. A lower interest rate may let you keep more of your money. Be sure to read the new finance agreement before you sign it. You need to check that the loan does not go on for too long.

How Personal Contract Purchase (PCP) Deals Are Affected

In PCPs, negative equity can be common in the beginning. This is because most of what you pay covers the drop in the car’s value, not owning the car itself.

The balloon payment at the end is decided by the guaranteed future value, or GFV. If the market value goes down and is less than the GFV when your term ends, you may want to give the car back. This can be the better choice for you sometimes.

How Does a Lower Credit Score Impact Your Options?

A lower credit score can make it hard to get a new loan. If you try to refinance, lenders may not give you a good interest rate. This is even more true if you are in a negative equity situation. A lower credit score can also lead to a higher interest rate on your new loan.

When Is Negative Equity Most Likely?

• The first two or three years of car financing for a long time can feel hard for people.
• If you get a newer model, it can lose its value very fast in the first years.
• When you choose lower monthly payments with a small deposit or no deposit, this can change how things go for you.
• It can be tough for us when there is a downturn in the economy, and prices for used cars drop fast.

Contract Purchase for Business Vehicles

Companies that choose contract purchase deals can end up with negative equity too. If they swap out the car before the deal ends, the settlement figure may be higher than the market value of the car. In this case, the business could owe more money than the car is worth.

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Strategies to Avoid Negative Equity in the Future

1. Make a larger down payment – It is good to put down at least 20%. When you do this, the loan amount you need to pay will be less.
2. Choose a shorter loan term – A shorter loan term will make your monthly payments higher, but you will build up more equity faster.
3. Buy vehicles with slower depreciation – Try to find out which cars keep their value best before you buy. This will help you later.
4. Avoid rolling debt into a new loan – If you add your old debt to a new loan, you will have more debt. This can put you at risk for negative equity for a long time.
5. Compare car finance options thoroughly – Every lender offers different loan terms and interest rates. These things can really change your equity.

How Compare Car Finance Helps You Make Better Financial Decisions

When you compare car finance deals, you get to see how the loan amount, loan term, and interest rate can change what you end up paying. This way, you know what you will get before you agree to anything. Picking the right deal early can help you stay away from a negative equity situation in the future. It also lets you find lenders who let you make extra payments without a penalty. This means you have more choices in case your financial situation changes.

FAQs About Negative Equity on Car Finance

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