Learn About Negative Equity Car Finance And How To Handle It

In this blog…

👉 What is Negative Equity?

👉 Why Do You End Up in Negative Equity?

👉 Why is Negative Equity a Concern?

👉 Types of Car Finance and Negative Equity

👉 Factors Leading to Negative Equity in Car Finance

👉 Handling Negative Equity

👉 How to Avoid Negative Equity

What Is Negative Equity?

You owe more money than your car is worth. This is negative equity. If you owe £4,000 to your finance company, but your car is now valued at only £3,000, you have £1,000 in negative equity.

Usually, car finance contracts balance out. This is because the car’s depreciation slows down as you continue making regular payments. Depreciation value is the rate at which something loses value.

How Do You End Up In Negative Equity?

Getting into negative equity can happen really easily. Here are some of the ways you can end up in negative equity:

1. Changing Cars: Changing your car might cause you to end up in negative equity.
2. Payment Struggles: If you are struggling to make your payments every month, you could end up in negative equity.
3. Accidents: Let's say you have an accident, and your insurance doesn't cover it. This could see you end up in negative equity.

Why Is Negative Equity A Concern?

Having negative equity can lead to lots of problems. This is even more likely if you struggle financially, especially in meeting payments. With your loan balance worth more than the actual car, trading it in won't cover you. This could lead to late fees if you miss payments.

Types Of Car Finance And Negative Equity

The chances of being in negative equity change depending on the type of car finance you choose. Here’s how it works for hire purchase (HP) and personal contract purchase (PCP) agreements:

Hire Purchase and Negative Equity:

With HP, you pay a fixed monthly fee and own the car outright at the end of the term. It’s less common to fall into negative equity with HP. This is because you’re paying off the car’s total value more quickly than with a PCP agreement. With it being quicker, there's less time for the value of the car to fall. However, suppose you do end up in negative equity. In that case, you can cancel your current HP agreement and take out a loan for a cheaper vehicle, incorporating the negative equity.

Negative Equity with PCP:

PCP typically offers lower monthly payments due to an optional balloon fee at the end of the deal. This often results in the amount owed exceeding the car’s value. If you have PCP car finance with negative equity, you do have some options.

• Return the car.
• Pay the balloon fee.
• Take out a loan for a new car.

Factors Leading To Negative Equity In Car Finance

Several factors can lead to car finance negative equity:

1. Car Depreciation: Cars lose value over time, especially in the early months of ownership. High depreciation rates can lead to negative equity.
2. High-Interest Rates or Long-Term Loans: High-interest rates or extended loan terms can result in slower equity build up compared to the car’s depreciation.
3. Insufficient Down Payment: A small initial deposit can result in insufficient equity to keep up with the car’s depreciation.
4. Rolling Over Negative Equity: Attempting to solve negative equity by rolling it over into a new car loan can worsen the situation in the long run.
5. Overpaying for a Vehicle: Paying more for a car than its market value can put you at risk of negative equity.
6. Damage or Modifications: Aftermarket modifications or sustaining damage can decrease your car’s market value.
7. Early Trade-In: Trading in a car early in your finance agreement can lead to a lower car value than the outstanding loan balance.

Handling Negative Equity

If you find yourself in a negative equity situation, you have several options:

1. Stick with Your Current Deal: Can't afford the car but don't want to change it? You can continue your agreement. Negative equity often balances out over time.
2. Voluntary Termination: If you’ve paid at least half of your total finance package, you may be able to return the vehicle. Check with your finance company for any associated fees or conditions.
3. Pay Off the Negative Equity: Clearing the balance on your finance agreement eliminates negative equity. This can give you a fresh start for your next car finance deal.

How To Avoid Negative Equity

While it’s not always avoidable, there are steps you can take to reduce the risk of negative equity:

1. Choose hire purchase car finance for quicker equity buildup.
2. Research car depreciation rates before purchasing.
3. Make a substantial down payment to start with more equity.
4. Evaluate the value of add-ons before including them in your deal.
5. Match your borrowing amount and term with the car’s depreciation rate.
6. Maintain your vehicle in good condition.
7. Stay within your agreed annual mileage limit.

Already dealing with negative car equity? We can help. Marsh Finance can help you explore negative equity car finance options that suit you. We offer hire purchase (HP) and personal contract purchase (PCP) plans. We’ll guide you through the process, making sure you get the best deal. Explore our car finance options today.

Negative equity in car finance is a common challenge. Still, it can be managed with the right approach and financial guidance. It doesn't matter if you need to address negative equity, or avoid it altogether. Make sure you understand the factors at play, as well as the options on the table. This is key to making informed decisions about your car finance.

FAQs

What is negative equity in car finance?

Negative equity is when the value of your vehicle is less than the outstanding balance of your car loan. In essence, it means that you owe more money on the loan than the car is worth.

If you have negative equity, you may struggle to sell, or part exchange your vehicle. If this happens, you may be asked to pay the difference out of your own pocket or roll the negative equity into a new car loan.

How do you end up with negative equity?

You can fall into negative equity for a number of reasons. It may be that the car you have purchased has depreciated faster than expected, or it could be because of the interest rate on your loan.

Can I change my car if I’m in negative equity?

Yes, you can change your car while in negative equity, but you’ll usually need to settle the difference between its worth and what you still owe. Some lenders or dealerships may help by rolling the shortfall into a new finance deal, but this can be expensive.

How does negative equity affect getting a new car finance agreement?

Being in negative equity can limit your options for new car finance. Lenders may see you as a higher risk, especially if you’re looking to borrow more than the value of the new car. You may need a larger deposit or to clear the shortfall before starting a new agreement.

What are my options if I can’t afford the negative equity shortfall?

If you can’t afford to pay the negative equity upfront, some lenders might allow you to refinance or extend your loan. However, it’s important to consider the long-term cost of borrowing more. Speaking to your lender or a car finance broker can help you understand your options.

Can I part-exchange my car with negative equity?

Yes, but you’ll need to cover the negative equity somehow. This usually means paying the difference in cash or adding it to your new finance agreement. Keep in mind that rolling over negative equity can make it harder to build equity in your new car.

Does voluntary termination clear negative equity?

Voluntary termination under the Consumer Credit Act (Section 99) allows you to return the car once you've paid 50% of the total finance amount (including interest and fees). If you're in negative equity but have passed the 50% mark, you can exit the agreement, but you won’t get any money back, and it won’t clear the gap between what the car is worth and what you still owe.

Can negative equity impact my credit score?

Negative equity itself doesn't directly affect your credit score. However, missing payments or defaulting on your finance agreement due to affordability concerns can damage your credit rating.

How do you deal with negative equity on car finance?

If you’re looking to reduce the negative equity on your car finance agreement, you can:

• Make extra payments: If possible, paying more than the required monthly instalment can help reduce the outstanding balance faster.
• Extend the loan term: While this may lower monthly payments, it could result in paying more interest over time.
• Refinancing: Refinancing can help you change your repayment terms, such as lowering monthly payments, but it might also increase the total interest paid or extend the loan term. Be sure to compare offers thoroughly before deciding.
• Trade in the car: Trading in (also known as part-exchanging) your current vehicle for a cheaper option can help reduce negative equity, although it may not eliminate it entirely.

How can I avoid negative equity?

It’s not always possible to avoid negative equity in your car finance agreement. Market changes can often have a big impact as used car prices can fluctuate dramatically. However, here are some tips on how to minimise the risk of negative equity:

• Deposit: Putting a higher deposit down reduces the likelihood of negative equity, as there is less of the cars value to pay back over the remainder of your loan. It’s important that you do some research before committing to a hefty deposit, and you should only put down what you can afford.
• Choose a shorter loan term: A shorter repayment period can decrease the chance of owing more than your car’s value. However, shorter repayment terms will increase your monthly payment amount.
• Do your research: Before buying a new car, check the model's depreciation rates online.

How much is negative equity on a car?

It depends. The negative equity on a car depends on things like the initial loan amount, the vehicle's depreciation rate, and any additional fees or interest you have accrued. It could be as little as a couple hundred pounds, but for some, it could be thousands. The amount of negative equity ultimately depends on the car itself and the state of the used car market at any given time.

Does GAP insurance cover negative equity?

Some gap insurance policies may cover negative equity, but only in specific situations, such as if your car is written off or stolen, and the insurance payout is less than your outstanding car loan balance. However, it’s important to check with your own insurer as coverage varies depending on your policy terms and conditions.

Does putting down a larger deposit reduce my chances of negative equity?

Yes, putting down a larger deposit can help reduce the likelihood of negative equity by lowering the initial loan amount and decreasing the gap between the car's value and the loan balance. However, this isn’t an exact science. Factors outside of your control, such as depreciation and used car prices, can force you into negative equity even if you have put down a big deposit.

If you’re financing a car on PCP (Personal Contract Purchase), it may not be a good idea to put down a large deposit. This is because of the risk of depreciation in the cars value, so we’d definitely recommend that you seek advice before making any big decisions.

Should I be worried about negative equity?

While negative equity can sound daunting, it’s quite common and shouldn’t necessarily be seen as an issue for immediate concern. However, we’d recommend that you address negative equity proactively to avoid any potential financial difficulties down the line. If you’re able to, making additional repayments can help to reduce negative equity.

Can I downgrade my car on finance?

Yes, you can downgrade your car on finance. However, it’s important to think about your options, especially if you have negative equity on your current vehicle. Downgrading to a cheaper car may help you reduce your monthly repayments, but if you have negative equity on your current vehicle, you may be asked to pay the shortfall before being approved for a new loan.

Does negative equity impact your credit score?

No. Negative equity itself does not impact your credit score. However, if you miss any payments or default on the loan due to negative equity, this will impact your credit score. It’s really important to stay on top of loan payments and take a proactive approach to negative equity to avoid any negative effects on your credit score.