Car finance: Negative equity and why it’s a problem

Car finance advice
Car finance - the negative equity problem (The Car Expert)

One of the problems car buyers often get caught out by with regard to their car finance is negative equity, and it can get them into financial trouble. But what is it and why is it a problem?

In this article, we will look at the following:

  1. What is negative equity?
  2. Why is negative equity a problem?
  3. Why carrying over negative equity is a bad idea
  4. How to minimise your negative equity

What exactly is negative equity?

Equity is the difference between what you owe to the finance company for your car loan and what the car is actually worth. If you car is worth more than you owe the finance company, the difference between the two is your equity. It means that if you sell the car, you can pay off your finance and still have something left over. Yay!

If your car’s value is less than what you still owe on it, that difference is called negative equity. That means that if you sell the car, the money you get for it won’t be enough to pay off your finance and you will have to pay the difference from your savings. Not so good.

For example:
Current car finance settlement: £16,000
Current car value: £12,000
Negative equity: £4,000

This is caused by the car losing value faster than you are repaying the loan. It will always happen at the start of your agreement and that’s perfectly normal, but it becomes a problem if there is still a significant negative equity difference later in the agreement, at the time when you are thinking about selling or changing your car.

Discussing part-exchange prices at a car dealership

“So, your finance settlement is £16,000 but your car is only worth £12,000. Is that about what you were expecting?” “What does that mean?” “Don’t worry about it…” (ominous music plays in background)

Having significant negative equity is very likely if your finance agreement is a PCP (personal contract purchase), especially if you have a small deposit and/or are taking the finance agreement over a long period (4+ years). Given that this exact scenario applies to millions of car owners in the UK, it’s fair to say that there are a lot of people who could potentially be in serious trouble if their financial circumstances change.

Why is negative equity a problem?

If your financial situation changes (eg – you lose your job, divorce or hospital expenses, etc.), you may be in a position where you can’t afford to keep up your monthly car payments. If your car finance is in negative equity, then even if you sell the car you still haven’t got enough money to pay off the debt to the finance company.

The example shown earlier had £4,000 of negative equity. If you were selling that car, that means you would need to find £4,000 on top of what the buyer has paid you in order to clear the finance still owing on the vehicle. And the majority of car owners won’t have that £4,000 available to settle the debt.

If you default on your debt to the finance company, they will charge you late fees on top of the payments you already can’t pay. So your debt goes up, making your situation worse. When you still can’t pay, the finance company will call in a collections agency and that will take your problems to a new level. In addition, your default on the loan will hit your credit score, making it harder to borrow money in the future or try to manage your way out of the problem. It’s a downward spiral that can easily end up in bankruptcy.

If you have other finance problems, negative equity on your car finance could push you into bankruptcy

Does the thought of this keep you awake at night?

This scenario is very common in car finance. If you have a hire purchase, you will usually have negative equity until you are about two-thirds of the way through your agreement (depending on how much deposit you paid up-front).

If you have a PCP agreement, you may end up being in negative equity all the way through to the end of the agreement and have to rely on giving the car back to claim your GMFV (guaranteed minimum future value) to cover your negative equity.

Carrying your negative equity over simply increases your risk

If you want or need to end your agreement early and change your car, you will almost certainly have negative equity to deal with – particularly if you have a PCP.

What people are often inclined to do is add their negative equity debt onto their new finance agreement. Some finance companies will simply not allow this, and in the aftermath of the financial crash of 2008 there was a bit of a crackdown with finance companies refusing to allow buyers to transfer negative equity from their old car to their new one.

However, it seems that this practice is on the rise once again. Anecdotal evidence here at The Car Expert suggests that it is becoming increasingly common, and that more finance companies are now allowing it. This is concerning.

What usually happens in this scenario is that the salesperson at the dealership breaks the bad news that your part-exchange is worth less than you thought, and that it’s not enough to cover the balance still owing on your finance: “But you don’t have to worry! We can just carry that amount over onto your new finance agreement, and all that will happen is that you’ll pay a few pounds more per month to cover it. It’s easy.”

At this point, the salesman will sit back, offer his best reassuring smile and insist that’s it’s no problem whatsoever.

Except that’s not really true…

A car salesman is not your friend, no matter how much he is smiling

Believe it or not, this guy does not really have your best interests at heart…

Let’s go back to the example at the top of the page: You have £4,000 of negative equity in your current finance agreement, and you want to borrow an extra £4,000 on your new agreement to pay that off. What the dealer will almost always fail to mention is that you have already paid interest on that £4,000, and you are now going to pay more interest on the same money because you are borrowing extra to cover it. But that’s only a minor problem. The major issue is that you are paying an extra £4,000 over and above the price of your new car.

Let’s say your new car costs £30,000. Your new finance agreement will include interest and fees, so your total amount repayable on the finance would probably be about £34,000. That’s already a negative equity of £4,000 before you have even started.

That new car will depreciate just as quickly as your old one, but the extra £4,000 of debt that you have whacked on top of the price means you will have an even bigger negative equity situation this time around, because you have basically paid £38,000 for a £30,000 car. So if you run into any financial problems over the next three or four years, you have multiplied your problems.

Next page: How to avoid or minimise your negative equity

Stuart Masson

Stuart is the Editor of The Car Expert, which he founded in 2011, and our new sister site The Van Expert. Originally from Australia, Stuart has had a passion for cars and the car industry for over thirty years. He spent a decade in automotive retail, and now works tirelessly to help car buyers by providing independent and impartial advice.

24 Comments

  1. Tell them they can volentry terminate may help people to,

    Reply
    • Stuart Masson

      Hi Joe. Voluntary termination will help in some situations, but we’re not going to advise people to go into a contract with the intention of VTing at a later date. The whole point of VT is to protect consumers whose circumstances have changed beyond their control. It’s not something to be used as a plan to avoid your contractual obligations from the outset.

  2. Another common myth you get told by the salesman is that at the end of the PCP agreement you will have enough equity in the car to be a deposit for a new one.
    I’ve not seen any evidence of this. At the end of my last agreement (or a couple of months before it was due to finish) I have negative equity, and my wife is currently being asked to “upgrade” her car, and sure enough the current value is exactly the same as the finance left on the car.
    I used to be a big fan of PCP, but it’s beginning to feel as if I’ve been mis-sold something. Is this the next PCP scandal?!

    Reply
  3. I still have 15 months left on my current contract with passport from Peugeot. They offered to bring me out of negative equity in order for me to get a new car early. They didn’t mention anything about carrying negative equity over. Should I be cautious? The sales person made it seem like peugeot finance would just write off the difference if I went for a new car.

    Reply
    • Stuart Masson

      Hi Chris. The finance company won’t write off the difference; it will be accounted for somewhere. For more information, have a read of our article about the myth of the early upgrade.

  4. When you enter into a vtermination what is the exact time allowed for instance 2 years of a 4year agreement or after paying half of loan and if you have a balloon on the end does this make a difference

    Reply
    • Stuart Masson

      Hi Brian. The VT point is half of the total amount payable, not halfway through the term. If you have a balloon, then it includes half of the balloon payment as well (since you have borrowed that balloon amount, even if you don’t inted to pay it back). For more information, read our complete guide to voluntary terminations.

  5. If i am on a lease deal, does negative equity affect me if im keeping the car for the full term and handing it back? And if it doesn’t should a salesman really be scaring me with negative equity talk?

    Reply
    • Stuart Masson

      Hi Jodie. If you’re on a lease (such as PCH) rather than a PCP, then you are simply renting the car. Negative equity is entirely irrelevant and the salesman should know better (although they often don’t).

      All you need to worry about are your mileage, your servicing and your vehicle condition to make sure you are complying with your lease terms.

  6. Thanks Stuart, this is what i kinda of thought. Unfortunately my father has put down a £2,000 deposit as he was scared about the negative equity gap growing the longer he left it, he had no paperwork and now they wont refund the £2,000. Where do you think i should turn?

    Reply
  7. What are the chances of paying g a lower final payment to buy the car if negative equity exists? Will a big finance arm, eg BMW, negotiate a lower figure if they stand to loose more if the car is handed back.

    Asking for a friend.

    Reply
    • Stuart Masson

      Hi Tom. Generally no, the finance companies have not ben prepared to negotiate a lower settlement. From their point of view, they would back their ability to recover enough money from selling the car at auction and charging you for anything they can get away with.

  8. Thanks for that.
    I’m 14m from the end of a deal and the diesel price crash has created quite a hole. Faced with the idea that next year my Countryman SD will be worth 1.5-2k less than the gmfv. Think I want to keep the car but paying that much more than trade value will stick in the craw a bit.
    I wonder if the fact I have minor damage insurance might tip the balance a little my way.. just have to wait and see I guess.

    Reply
    • Stuart Masson

      In which case you give the car back to the finance company and buy a similar one for less money elsewhere.

  9. This site is good – I have a PCP – wish I had gone HP or got a cheaper normal car – I drive BMW Z4 M sport – dealer was great at selling me the first one then work changed my contracts so I went for a MINI – cheaper then silly me wanted a Z4 back and – Wham now have £8k negative on a 2014 model low miles. – Work are now reducing my hours and overtime – So I was looking at a cheaper car – but I can not get finance for the extra – I can for 16k car loan well I could but BMW Finance have sent my credit rating to fair when I was near top of good. Should I ask for a settlement figure and see if the dealer comes back to me and offers me a cheaper car and not at £560 per mth x 36 with balloon of £8k

    Reply
    • Stuart Masson

      Hi Rupert. If you have £8K of negative equity, your priority should probably be to reduce this as quickly as possible. Changing your car again will almost certainly result in more negative equity – if a finance company is prepared to accept it (which is unlikely).

  10. Good Morning. I bought a new Vauxhall Corsa in March on a no Deposit PCP deal. I am about to lose my driving licence and my job as a result of a recent seizure/stroke. My car has only covered 2500 miles, but obviously I won’t be able to drive or pay for the car, with no savings to speak of, what are my options? Anthony

    Reply
    • Stuart Masson

      Hi Anthony. There won’t be any provision to cancel the finance agreement on medical grounds, so you will need to look at your own health insurance situation to see if there is anything that could cover you. Basically, you need PPI cover.

  11. Thanks Stuart, I don’t think I have any cover, as I was always very healthy. Would I be best to sell the car to settle some of the finance, or surrender car and borrow enough to make up the half value to settle the pcp contract.

    Reply
    • Stuart Masson

      Hi Anthony. We can’t advise on which path would be better for you and your circumstances. You would need to speak to a financial advisor.

      If your car is on a PCP, you don’t have the legal right to sell it anyway. You would need to speak to the finance company and ask them how you can manage it. Some are happy to agree a sale (particularly if you are selling to a car dealer) if the buyer settles the finance in full and you pay any difference to the buyer, but others are not supportive of any attempts by you to sell the car.

  12. Thanks – Stuart – i’m keeping my car and will see what to do in 3 years – as you say can hand back or keep it – I love my Z4 Thanks again

    Reply
  13. I am about to chande my car the car has negitive of £6433.31 peter vardy wants to pay it off n give me new car @ 9800 but wot i dont get by my caculations they say my car is worth £3500 so do i deduct that from the £6433.31 if i do that leaves £2933.31 but when i look at the agreement i see they have added £3500 to new car agrement take about confused .com some things not right can you point me in right path please ASAP many thanks paul

    Reply
    • Stuart Masson

      Hi Paul. Adding negative equity to your new agreement is not a good idea. It will put you in a very vulnerable position if you hit any financial bumps in the road over the next few years, as you are paying £13,300ish (plus interest and fees on top of that) for a £9,800 car.

      We can’t comment on your specific details based on incomplete information (you’d need to go over the quote or contract line by line to understand exactly how they have come up with their numbers, and that’s not something we do), but you are perfectly entitled to ask them to run through it in detail with you until you are comfortable that you understand what it all means.

What are your thoughts? Let us know below.

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