What is negative equity in car finance?
In the UK, the majority of new cars are purchased on finance, and a growing number of used cars are, too.
Equity in car financing refers to the difference between the current market value of a car and the total amount of money owed on it (including fees and interest). If you’re in negative equity, the car’s value is lower than your debt. The reverse – having a higher valuation than debt balance – is positive equity.
If you sell or trade in your car while in negative equity, you will have to pay out of pocket the difference between what’s left on your loan and your vehicle’s sale price. Alternatively, selling when you’re in positive equity leaves you with some money to put towards your next vehicle.
It’s essential to stay informed about your car’s current market value and the status of any outstanding loans to make informed financial decisions.
- Negative equity 101
- What is a Guaranteed Future Minimum Value?
- What causes negative equity?
- How can I avoid negative equity?
- How can I manage negative equity?
Negative equity 101
Equity in car financing can be positive or negative, depending on whether your car is worth more or less than your outstanding loans. In the UK, most car financing agreements are arranged so that you begin and stay in ‘negative equity’ for at least half of the duration of your contract.
Your vehicle’s equity changes over time as your car’s value depreciates, you pay off your loans, and in response to global market conditions. Initially, car values drop after purchase. Then, this depreciation generally slows, at which point your loan payments might catch up, resulting in your equity becoming positive.
Positive equity can be advantageous when you decide to sell your car. As your car value is greater than your outstanding finance, when you sell your vehicle on positive equity you can receive and pocket the extra funds.
However, if the depreciation of your car’s value outpaces your loan payments, so you continually owe more than your car is worth, you will stay in negative equity. Having negative equity can limit your ability to sell or trade in your vehicle without incurring financial losses. You might find yourself owing money even after selling the car.
Being in negative equity on your car finance can limit the feasibility of upgrading to a new vehicle, but understanding the changing value of your financed car is a great way of getting much better value, and making the best decisions about when to sell.
What is a Guaranteed Future Minimum Value?
When you enter into a PCP car financing agreement, your finance company guarantees what your car will be worth at the end of your payment period, regardless of its actual market value at that time. Taking into account factors such as mileage and condition, this predetermined, estimated cost is called your Guaranteed Minimum Future Value (GMFV).
Also known as the Guaranteed Future Value, balloon payment, or optional final payment, your GMFV is contractually the lowest amount that your car will be worth at the end of your loan.
GMFV provides a degree of certainty for both buyers and finance companies. For the buyer, it indicates the car’s future value, allowing for easier budgeting. When your contract ends, you can “buy out” and keep your car by paying off the GMFV. For the finance provider, the GMFV helps mitigate the risk of depreciation and ensures the recuperation of funds at the end of the contract.
However, the GMFV comes with strings attached. Buyers need to understand its terms and conditions, including mileage limits, maintenance requirements, and wear-and-tear charges.
It’s also crucial to consider that the GMFV may not accurately reflect the true market value of your car at the end of the contract term. If your vehicle is actually worth more than the GMFV, you can use the equity towards your next set of wheels. If it’s worth less, then you can just hand it back.
What factors impact car equity?
Similar to the value of your vehicle, a variety of factors influence the value you will get from your car financing agreement. The lower your car’s valuation is, and the higher your interest rates, the less value you’ll get.
- Car depreciation: All cars depreciate in value over time, but the rate at which their price changes varies. A rapid drop in price early on could create a scenario where the outstanding balance on your loan is significantly more than the car’s depreciated value, making it harder to get out of negative equity. Stay on top of your car’s shifting value to make informed decisions on when to sell.
- Financing terms: Review your financing agreement carefully! Longer loan terms with lower repayments mean a slower reduction in the principal amount owed, which can lead to you owing more than your car is worth.
- Interest rates: Elevated interest rates lead to more significant interest accrual, which increases the amount of time it takes longer to pay off your principal loan amount.
- Insufficient deposit: A low initial downpayment means starting with a higher loan balance, increasing your time in negative equity.
- Rolling over debt: Carrying over outstanding balances from previous cars into a new loan can amplify negative equity that struggles to catch up to your car’s value once you’re ready to sell.
- Market fluctuations: Shifts in the global economy and the car market can impact your car’s valuation as well as your financing terms, having an impact on both your equity level and your valuation.
How can I avoid negative equity?
The faster your car’s value depreciates, the higher the risk of remaining in negative equity. The factors within your control that drive depreciation are mileage and condition. When purchasing a car, consider reputable car brands and models known for retaining value.
If you’ve agreed to a longer-term finance arrangement to cut down on monthly repayments, you’ll likely end up paying more in the long term thanks to compound interest. Shorter loan terms help you pay back your principal quicker, reducing time spent in negative equity. Maintaining a good credit score can also help you secure favourable interest rates.
The best way to tip into neutral or positive equity is to increase your monthly payments, or even make some overpayments if possible. This helps you pay off your debt (and its compounding interest) quicker than your car value depreciates. This tactic helps align your car’s value with your outstanding loan and reduces your total loan repayment time.
How can I manage negative equity?
- Repay negative equity upfront – If you’re financially able, one way of managing negative equity is settling your outstanding loan balance, or at least the amount that exceeds your car’s current market value. By proactively closing the equity gap, you can get rid of your negative equity and align your loan balance with your car’s worth.
- Refinance and roll negative equity into a new loan – Explore refinancing options to roll the deficit into a negative equity finance deal. Although this will extend the length of your monthly payments, it provides immediate financial relief by incorporating the negative equity into a new arrangement.
- Sell your car privately – Selling your car can be a strategic move to minimise financial losses. Private sales often fetch higher prices than trade-ins, helping bridge the financial gap between your outstanding loan and the car’s market value.
How can I finance my car if it has negative equity?
Securing car finance with negative equity is challenging. Lenders may consider it, but interest rates might be higher. A larger down payment or trading in a current car with positive equity improves your chances of approval.
However, there are options available. These include rolling the negative equity into a new loan, paying it upfront, or finding lenders specialising in such situations. Higher interest rates or extended loan terms may apply, so be sure to carefully evaluate financing possibilities.
How can I avoid negative equity car finance in the future?
Avoid negative equity by choosing a new car with strong resale value, opting for shorter loan terms, making larger down payments, and staying informed about market trends. Regularly reassess financial situations to align with vehicle depreciation rates.
What steps should be taken when applying for car finance with negative equity?
When applying for car finance with negative equity, it’s important to assess the extent of their negative equity and explore refinancing options. Seeking lenders experienced in handling negative equity scenarios. Know all of your options, from larger down payments to different interest rates and loan terms, before making a financial decision.
How can I track the value of my car?
If you’re not sure what your car’s value is to begin with, it’s hard to know how much money being in negative equity might take off the price.
All vehicles depreciate at varying rates, with no rule of averages accurately describing any one car’s changing value. Motorway’s Car Value Tracker provides a free, reliable monthly price alert for up to six vehicles at once.
Follow changes to your car’s value to choose the best time to sell, and make informed choices about investments in your car’s maintenance.
Should you sell your car?
Want to learn more about the best ways to sell your car? Check out more of our guides here, covering everything you need to know about different finance schemes, and what they mean for you as a car owner.