Negative equity car finance: everything you need to know

  • Equity and negative equity explained
  • Why they both matter for your PCP finance deal
  • GAP insurance, Voluntary Termination and best practice also explained

Car dealership

Sign up for PCP finance and you're bound to 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.

For example, 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 left at the end of your finance agreement 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.

What is negative equity car finance?

Negative equity happens when the value of an asset is less than the outstanding debt. In a car finance agreement, it's possible for your car to be worth less than the remaining debt. This is the case in the early stages of most contracts.

How does equity affect PCP car finance?

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 (sometimes known as the balloon 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.

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.

2020 Range Rover Evoque

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 car finance: 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.

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.

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.

Negative equity and 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.

2020 Mazda CX-30

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.

>> Can I voluntarily terminate my car finance deal early?

Negative equity car finance 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.

2020 Citroen C1

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.

Further reading

>> Excess mileage charges and how they cost you dearly
>> What happens at the end of a PCP finance deal?
>> Best cars for £90 per month
>> Best cars for £100 per month
>> Best cars for £150 per month
>> Best cars for £200 per month
>> Best cars for £300 per month
>> Best cars for £400 per month
>> Top PCH, PCP, and cash deals