Negative Equity

What is negative equity in car finance? 

Negative equity is a concept that is common in property, where reductions in property prices can leave home owners in a position where they end up owing more on their mortgage than their actual home is worth. 

Until recently, negative equity wasn’t a concern for car owners, however the rise in the popularity of care financing packages has meant that more recently negative equity has become an issue for motorists as well as homeowners. 

The issue of negative equity can, for instance, cause issues when it comes to selling a financed car. Being in negative car equity means that the amount owed to the financing company exceeds the current value of the car. 

A lot of motorists assume that the situation is rare, however that actually isn’t the case - it’s not as rare as you might think. Particularly when brand new car models are purchased. You see, in the short-term following the selling of a vehicle, this is when the car’s value is most likely to decrease. 

What this means is that for a motorist buying a car on finance, the car’s value dipping below the balance of the loan would not be all that unusual. The good news is that what normally happens is over time, the rate of depreciation begins to reduce as the loan is repaid on a monthly basis.

Of course, should a motorist who has bought a car on finance want to sell their car while in negative equity, this can cause a serious issue. Say, for instance, as you can no longer afford the monthly repayments, you want to sell your vehicle during the loan period or want to trade up and invest in a larger vehicle. 

When it comes to selling a car on finance or you want to part-exchange that car, you will need to pay back the entire loan balance in order to be able to make a sale. However, the issue is that if the car is now worth less than the loan balance, you would then need to make up the extra out of your own pocket. 

Negative equity can also cause problems if a vehicle is stolen or is written off as a result of a car accident, as often insurance companies are only able to pay out the market value of a vehicle at the time the claim is made. 

Again, if the loan amount at this time is higher than the value of the car, then you would have to make up the remaining amount. 

What to do if you are in negative equity with your finance

What are your choices if you end up in negative equity with your car finance?

  • You could opt to do nothing and simply keep making your repayments, as long as they are affordable that is. 
  • You could also choose to sell or trade in your car and then make up the difference out of your own pocket.
  • You could choose to trade your current car in for a cheaper model and take out negative equity finance to make affording the outstanding loan and new payments more affordable. 
  • You could also apply for a voluntary termination - this is only an option if at least half of the total amount payable.

It’s also important to consider looking into getting a Guaranteed Future Value (GFV) plan in place which is part of a Personal Contract Plan (PCP). A GFV plan is when a car finance company is able to guarantee what the vehicle you are buying will be worth at the end of the finance period, regardless of the ‘true depreciation’ of the vehicle’s value. Having this guarantee in place.

You should also aim to understand the residual value of the vehicle, which is the estimated wholesale value that the car should retain by the end of the leasing period. For instance, say you lease a car worth £30,000 which is expected to depreciate by 20% over the first 12-months, the vehicle’s residual value would work out as £24,000. The residual value is used by financing companies to work out the price of monthly finance repayments, so it’s an important number to take note of. 

However, if you plan on buying the vehicle outright at the end of the lease period, then you may want to opt for a vehicle with a lower residual value. Although your monthly repayments will be higher, the price that you pay at the end of the term to purchase the car will be lower. 

Is it possible to Restructure if you are struggling to keep up payment?

If you are in a position where you want to start a new car financing agreement because you can’t afford to keep paying for your current vehicle. The first step to take is to get in touch with your finance provider and discuss the situation with them. You may be able to work out a solution where they are willing to restructure your loan - potentially offering a longer repayment period. This is possible whether you’re in negative equity or not. 

There are also a number of specialist companies that provide car finance agreements for motorists who are currently facing negative equity. You may be able to trade in your current vehicle and switch to a different option. 

These specialist agreements for motorists who are in negative equity, tend to incorporate the costs of clearing the negative equity amounts along with the price of the new vehicle, and offer a single monthly repayment plan set over a fixed period of time.