PCP finance: everything you need to know about equity and why it's important

  • Equity: the difference between a car's current value and outstanding debt
  • Negative equity: when the remaining debt is greater than the car's worth
  • GAP insurance, Voluntary Termination and best practice also explained

Sign up for PCP finance and you may come across the word ‘equity’. This refers to the difference in value between how much your car is worth at any time and the outstanding amount you owe through the car finance agreement.

Consequently, if your car is worth £10,000 and you have £9,000 left to pay, there’s £1,000 worth of equity in the vehicle. The greater the equity, the more money you have to put towards a deposit on your next car if you hand your old one back to the dealer and step into another PCP scheme.

It is also possible for your car to be worth less than the remaining debt, however, which is the case in the early stages of most contracts. This is known as negative equity.

Keep reading to find out how to use your car’s equity to your advantage.

If you’re still considering your options, take a look at the Parkers car finance calculator to see how much you can afford to borrow and read more about PCP finance, Hire Purchase and PCH leasing to decide which works best for you.

And, if you’re already set on PCP finance, check out the links below to find the best car for your budget:

How does PCP car finance work?

With PCP finance you put down a deposit – though you don’t have to pay anything upfront in many cases – followed by a series of fixed monthly payments.

Get to the end of the contract and you have several choices. Firstly you can hand the car back with nothing left to pay (assuming you’ve stuck to pre-agreed mileage limits and the car has been well looked after).

Secondly, you can make the optional final payment to buy the car outright. At this point, you could choose to sell the car, freeing up any equity over the final amount you paid to buy the car.

Car finance: what is equity?

What most drivers do, however, is trade the car in for a new model on another PCP contract. If you do this, you can cash-in any equity the car may have, adding it to the deposit on your next car, in order to reduce your monthly payments.

PCP typically leaves you with equity shortly before the end

As most cars lose value fastest when they’re brand new, you start the contract with negative equity – where the outstanding debt outweighs the car’s value – and steadily pay this off.

As the contract progresses and the car’s depreciation slows, the fixed payments chip away at the debt until – in most cases – the car is worth more than the amount left to pay, leaving you with some extra cash in your pocket.

Most PCP schemes are calculated to leave you with some equity as you near the end of the contract. That means that you can often hand the car back early and still have a little cash to put down as a deposit on your next car – depending how soon you change car.

Negative equity: what you need to know

PCP contracts don’t always leave you with equity, however. It is possible to end up with negative equity – even at the end of the contract. If you have £9,000 left to pay but the car is only worth £8,000, that would leave you with £1,000 of negative equity, so even if you gave the car back, you'd still owe £1,000.

Car finance: what is equity?

This could occur earlier on in the contract, when you haven’t had a chance to pay off much of the balance. Or at the end, should the optional final payment to take ownership of the car be greater than its value. Where you are in the contract affects your options.

If the car’s worth less than the optional final payment at the end of the term, fear not. That’s the finance company’s loss. As long as the vehicle’s in good condition and below the pre-agreed mileage limit, you can return the car with nothing left to pay and simply walk away.

Want to find out more about car finance? Take a look at the stories below:

Even if you love the car and want to keep it, you could be better off purchasing an equivalent used model – for less than the optional final payment would set you back. Or you could even try negotiating with the finance company for a new settlement figure to reflect your model’s drop in value, if you’re set on keeping that specific car.

Voluntary Termination: how to return your car early

Meanwhile, if you’re earlier in the contract but have paid more than half of the total balance due, you can return the car through a process known as Voluntary Termination (VT) with nothing else to pay – regardless of whether there is negative equity in the car.

Be aware, though, that this will be logged on your credit file, and if you do this two or more times lenders may be less willing to accept you for finance again – as each VT is likely to add to their costs.

Car finance: what is equity?

If, however, you’re early on in the contract and haven’t paid half of the overall balance, you’ll have to pay the difference before handing the car back, or simply run the car until the halfway point.

Car finance: negative equity and GAP insurance

It doesn’t matter how certain you are that you can afford your monthly payments, it’s worth remembering that you’re still liable for instalments, even if the car is stolen or written off.

You may think that this isn’t a problem as your insurer will simply pay off the finance. However, that isn’t the case. Most insurers will simply pay out the current value for the car, which could leave you with thousands of pounds of negative equity.

Write off a 13-month old financed Skoda Octavia 1.6 TDI SE, for instance, and you could be liable for £4,000 more in outstanding finance payments than your insurer will pay out for an equivalent car. That’s because the insurer covers the current value of the car rather than the outstanding finance balance. This is where GAP insurance comes in.

GAP – Guaranteed Asset Protection – insurance covers the difference between how much your insurer would pay out for your car and how much is left to pay on the contract.

Do bear in mind, however, that most fully comprehensive insurance policies will provide a brand new car if yours was under a year old and stolen or written off. This can vary across insurers, so it’s worth double checking your policy documents rather than taking this for granted.

A number of GAP insurance formats are available. Some are designed to cover cars bought for cash, while others cover those bought with loans and through PCP, so do your homework before choosing a policy.

Also remember that while many dealers may offer this cover, these policies can be very expensive and feature many exclusions, meaning that they can offer very poor value for money. If you decide you want GAP insurance, therefore, it’s worth shopping around online to find the best price for the cover you want.

Don’t bank on equity: put money aside for your next PCP now

While PCP schemes are typically set up to leave you with a substantial amount of equity in the car at the end of the contract, you can never count on this. Just as the car could be worth more than expected at the end of the contract – leaving you with plenty of cash to put into your next contract – it could be worth less than anticipated, leaving you empty handed.

Car finance: what is equity?

Therefore, it’s wise to put a little money aside each month for a deposit on your next car, to make sure that you can get the car you want for monthly payments you can afford.

This is especially important, as finance payments for many new car finance schemes are likely to be higher when you come to replace your car.

This has partly been caused by the fall in the value of the pound, increasing new car prices and lower used car residual values in many cases.

Should the value of the pound fall further or interest rates rise, you can expect to have to pay more to step from your current contract into an equivalent new one.

Put aside a larger deposit, however, and you should be in a better position to get the car you want within budget.

Want to find out more about car finance? Take a look at the links below: