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Car finance ›
What is negative equity in car finance?
Updated: Thursday, 7 December 2023
Negative equity is often talked about when purchasing a car on finance, but you might not know what it is. Here, we explain negative equity finance, what it means for you, and how it can affect you when you take out a new finance agreement.
By understanding the significance of falling into negative equity with your financed car, you can take steps to minimise the chances of it happening to you.
What is negative equity on a car?
Negative equity is when the outstanding finance amount is more than the car’s current market value.
For example, your car is worth £6,000 but you have £8,000 left to pay on your car finance agreement. At that moment in time, there is £2,000 in negative equity.
Negative equity happens when a car’s value declines faster than your finance repayment schedule.
What is positive equity on a car?
On the other hand, you might be in positive equity. Being in positive equity means that the market value of your financed car is greater than the outstanding balance you owe.
For example, your car is worth £10,000 but you have £8,000 left to pay on your car finance agreement. At that moment in time, there is £2,000 in positive equity.
This means that when your finance agreement ends, if you decide to part-exchange and start a new agreement, you can use that £2,000 of positive equity as a deposit for your next car finance deal.
Why is negative equity a problem?
If you have negative equity, your outstanding finance is more than your car is worth. This could prove problematic in certain situations, including:
- If you experience a change in circumstances during your finance agreement and can no longer afford the monthly repayments, you will need to speak to your lender and discuss the options you have available.
- If your financed car is stolen or written off in an accident, your insurance provider will only make a payout of its market value at the time you make a claim. Again, in this instance, you would need to find the funds to cover the outstanding amount unless you have Guaranteed Asset Protection (GAP) insurance in place.
- Having negative equity on a vehicle could make it difficult to get a new finance agreement, as you will not have any positive equity to use as a deposit on a new vehicle.
Is negative equity always bad news?
Even though the idea of negative equity can seem like doom and gloom, it’s not always so. Since new cars depreciate most rapidly immediately after purchase, there will likely be a period of negative equity at the beginning of any car finance agreement.
But, when the rate of depreciation slows and gives your monthly repayment schedule time to catch up, this negative equity may well balance out.
Your lender can help you explore your options if you find that you have negative or positive equity and want to take out a new agreement.
Negative equity and car finance
Conditional Sale (CS) and Hire Purchase (HP) finance agreements
With Conditional Sale (CS) finance, you purchase a car by paying fixed monthly instalments over a pre-agreed term. Once you have repaid the total amount borrowed plus interest, you will automatically become the vehicle’s legal owner.
Hire Purchase (HP) finance agreements work in the same way, except you will need to pay a one-off ‘option to purchase’ fee to transfer ownership at the end of the term.
As the monthly payments tend to be higher with CS and HP than other types of finance (for example, PCP) you are less likely to fall into negative equity. This is because your repayment schedule may be shorter, as you pay more of your agreement off each month comparatively. This means there’s less chance of your car falling into negative equity.
If you do find yourself in negative equity with CS or HP car finance, you may be able to return the vehicle to the finance company and take out a new loan on a cheaper car. This will be subject to the terms and conditions of your current finance agreement. If you’re unsure, speak with your lender and they can help you explore your options.
Personal Contract Purchase (PCP) finance agreements
With Personal Contract Purchase (PCP) finance, you will likely pay smaller monthly instalments but make a final balloon payment to buy the vehicle at the end of the term.
Since you’re effectively paying off the value of your car at a slower rate, your loan-to-value ratio will remain higher until you make the final balloon payment. This means it can be more common for PCP finance agreements to lead to negative equity.
Moreover, lenders calculate your balloon payment based on the expected value of your car at the time the payment is due (i.e. at the end of your finance agreement term). If your car depreciates more than predicted, you could find that your balloon payment costs more than your car is worth.
Can you leave a finance agreement if your car is in negative equity?
If you have negative equity car finance and want to exit an agreement with your finance provider, you can do a few things. Everyone’s situation is different, but some of the options may include:
1. Voluntary termination
Under the Consumer Credit Act 1974, you can voluntarily terminate your car finance agreement early if you have already paid off at least half of the total amount payable.
2. Settling your agreement early
Some finance providers will let you pay a settlement figure to end your agreement early. Find out how finance providers calculate an early settlement figure with our guide.
3. Keep making your monthly payments
If you can still make your monthly payments and are happy with the car, there’s no need to worry. Negative equity won’t change the terms of your finance agreement. Anyway, if you keep up with your monthly repayments this will reduce your loan-to-value ratio and take your finance agreement out of negative equity.
How to avoid negative equity
Avoiding negative equity in a car finance contract is difficult because you can’t always know how quickly a car’s value will depreciate before you buy it.
You can reduce the risk of going into negative equity by:
1. Not exceeding your mileage allowance
As per the terms of your finance agreement, you may incur extra charges if you exceed your mileage limit – pushing you into negative equity. Our agreements don’t have a mileage restriction, but this varies depending on your lender and the type of finance you have. If you are unsure, check your contract and it will outline any restrictions.
2. Keeping your car in good condition
Looking after your car will help it retain its value, so ensure you keep your vehicle clean and get any damage repaired by a professional. For more information, check out our car servicing checklist so you can keep your car in good condition.
3. Putting down a bigger deposit
You can reduce your loan-to-value ratio by putting down a bigger deposit at the start of your car finance agreement. Doing this can also reduce your monthly repayments.
4. Opting for a used car
Used vehicles tend to depreciate at a slower rate than brand-new or recently-new models. If you’re worried about falling into negative equity, purchasing a second-hand car on finance could help you avoid this. If you’re trying to decide what car to buy, our guide on choosing between a new or used car should help.
Can I get car finance with negative equity?
No, unfortunately we do not offer negative equity car finance. We don’t clear negative equity on your current car.
Negative equity is often talked about when purchasing a car on finance, but you might not know what it is. Here, we explain negative equity finance, what it means for you, and how it can affect you when you take out a new finance agreement.
By understanding the significance of falling into negative equity with your financed car, you can take steps to minimise the chances of it happening to you.
What is negative equity on a car?
Negative equity is when the outstanding finance amount is more than the car’s current market value.
For example, your car is worth £6,000 but you have £8,000 left to pay on your car finance agreement. At that moment in time, there is £2,000 in negative equity.
Negative equity happens when a car’s value declines faster than your finance repayment schedule.
What is positive equity on a car?
On the other hand, you might be in positive equity. Being in positive equity means that the market value of your financed car is greater than the outstanding balance you owe.
For example, your car is worth £10,000 but you have £8,000 left to pay on your car finance agreement. At that moment in time, there is £2,000 in positive equity.
This means that when your finance agreement ends, if you decide to part-exchange and start a new agreement, you can use that £2,000 of positive equity as a deposit for your next car finance deal.
Why is negative equity a problem?
If you have negative equity, your outstanding finance is more than your car is worth. This could prove problematic in certain situations, including:
- If you experience a change in circumstances during your finance agreement and can no longer afford the monthly repayments, you will need to speak to your lender and discuss the options you have available.
- If your financed car is stolen or written off in an accident, your insurance provider will only make a payout of its market value at the time you make a claim. Again, in this instance, you would need to find the funds to cover the outstanding amount unless you have Guaranteed Asset Protection (GAP) insurance in place.
- Having negative equity on a vehicle could make it difficult to get a new finance agreement, as you will not have any positive equity to use as a deposit on a new vehicle.
Is negative equity always bad news?
Even though the idea of negative equity can seem like doom and gloom, it’s not always so. Since new cars depreciate most rapidly immediately after purchase, there will likely be a period of negative equity at the beginning of any car finance agreement.
But, when the rate of depreciation slows and gives your monthly repayment schedule time to catch up, this negative equity may well balance out.
Your lender can help you explore your options if you find that you have negative or positive equity and want to take out a new agreement.
Negative equity and car finance
Conditional Sale (CS) and Hire Purchase (HP) finance agreements
With Conditional Sale (CS) finance, you purchase a car by paying fixed monthly instalments over a pre-agreed term. Once you have repaid the total amount borrowed plus interest, you will automatically become the vehicle’s legal owner.
Hire Purchase (HP) finance agreements work in the same way, except you will need to pay a one-off ‘option to purchase’ fee to transfer ownership at the end of the term.
As the monthly payments tend to be higher with CS and HP than other types of finance (for example, PCP) you are less likely to fall into negative equity. This is because your repayment schedule may be shorter, as you pay more of your agreement off each month comparatively. This means there’s less chance of your car falling into negative equity.
If you do find yourself in negative equity with CS or HP car finance, you may be able to return the vehicle to the finance company and take out a new loan on a cheaper car. This will be subject to the terms and conditions of your current finance agreement. If you’re unsure, speak with your lender and they can help you explore your options.
Personal Contract Purchase (PCP) finance agreements
With Personal Contract Purchase (PCP) finance, you will likely pay smaller monthly instalments but make a final balloon payment to buy the vehicle at the end of the term.
Since you’re effectively paying off the value of your car at a slower rate, your loan-to-value ratio will remain higher until you make the final balloon payment. This means it can be more common for PCP finance agreements to lead to negative equity.
Moreover, lenders calculate your balloon payment based on the expected value of your car at the time the payment is due (i.e. at the end of your finance agreement term). If your car depreciates more than predicted, you could find that your balloon payment costs more than your car is worth.
Can you leave a finance agreement if your car is in negative equity?
If you have negative equity car finance and want to exit an agreement with your finance provider, you can do a few things. Everyone’s situation is different, but some of the options may include:
1. Voluntary termination
Under the Consumer Credit Act 1974, you can voluntarily terminate your car finance agreement early if you have already paid off at least half of the total amount payable.
2. Settling your agreement early
Some finance providers will let you pay a settlement figure to end your agreement early. Find out how finance providers calculate an early settlement figure with our guide.
3. Keep making your monthly payments
If you can still make your monthly payments and are happy with the car, there’s no need to worry. Negative equity won’t change the terms of your finance agreement. Anyway, if you keep up with your monthly repayments this will reduce your loan-to-value ratio and take your finance agreement out of negative equity.
How to avoid negative equity
Avoiding negative equity in a car finance contract is difficult because you can’t always know how quickly a car’s value will depreciate before you buy it.
You can reduce the risk of going into negative equity by:
1. Not exceeding your mileage allowance
As per the terms of your finance agreement, you may incur extra charges if you exceed your mileage limit – pushing you into negative equity. Our agreements don’t have a mileage restriction, but this varies depending on your lender and the type of finance you have. If you are unsure, check your contract and it will outline any restrictions.
2. Keeping your car in good condition
Looking after your car will help it retain its value, so ensure you keep your vehicle clean and get any damage repaired by a professional. For more information, check out our car servicing checklist so you can keep your car in good condition.
3. Putting down a bigger deposit
You can reduce your loan-to-value ratio by putting down a bigger deposit at the start of your car finance agreement. Doing this can also reduce your monthly repayments.
4. Opting for a used car
Used vehicles tend to depreciate at a slower rate than brand-new or recently-new models. If you’re worried about falling into negative equity, purchasing a second-hand car on finance could help you avoid this. If you’re trying to decide what car to buy, our guide on choosing between a new or used car should help.
Can I get car finance with negative equity?
No, unfortunately we do not offer negative equity car finance. We don’t clear negative equity on your current car.
For a better road ahead
Moneybarn is a member of the Finance and Leasing Association, the official trade organisation of the motor finance industry. The FLA promotes best practice in the motor finance industry for lending and leasing to consumers and businesses.
Moneybarn is the trading style of Moneybarn No. 1 Limited, a company registered in England and Wales with company number 04496573, and Moneybarn Limited, a company registered in England and Wales with company number 02766324. The registered address for these companies is: Athena House, Bedford Road, Petersfield, Hampshire, GU32 3LJ.
Moneybarn’s VAT registration number is 180 5559 52.
Moneybarn Limited is authorised and regulated by the Financial Conduct Authority (Financial Services reference No. 702781)
Moneybarn No. 1 Limited is authorised and regulated by the Financial Conduct Authority (Financial Services reference No. 702780)
