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

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

Avoiding or minimising negative equity

It’s almost impossible to completely avoid negative equity in car finance, as you are taking on a debt (plus interest and fees), against a rapidly depreciating asset. Even if you have an interest-free loan, the car will depreciate faster than you are repaying the loan to begin with. After a year or so, the rate of depreciation slows down and your repayments start to ‘catch up’. But on a PCP, it is still possible that you will never properly catch up and will always be in negative equity until the end of the agreement.

There are ways you can minimise your negative equity position, and it usually means going against what the dealer wants you to do. They are:

  • Have a larger up-front payment (deposit). The more you are putting in now, the less you have to repay over the next 3-4 years. You also pay less interest, as you are borrowing less money. Dealers will usually try to get you to reduce your deposit and borrow more (“Why wouldn’t you? The rates are so low!”), but this is only because the more you borrow, the more commission they get paid. It’s not for your benefit.
  • Take a shorter term, such as a three-year PCP instead of a four-year (or longer) PCP. Your monthly payments will be higher, but that’s because you are paying off more of the car each month and closing down your negative equity sooner. So if you run into problems down the track, your negative equity problem will be smaller and hopefully more manageable.
  • Don’t be tempted to change your car because you’re bored with it. Settling your PCP ahead of schedule is almost guaranteed to mean having to pay off negative equity.
  • Don’t underestimate your annual mileage. If you take a PCP at an annual mileage of 6,000, but you actually do 10,000 miles each year, you are creating a problem for yourself. Your payments will be lower, but you are devaluing the car faster because of the additional mileage. So if you need to sell the car, you’ve paid back less of the debt and have a larger problem.
  • Most finance companies will let you make overpayments; either in the form of higher monthly payments than what you have committed to, or extra payments here and there when you have some spare money available. This reduces your debt and therefore your negative equity position.
  • Don’t pay for any extras you don’t want or need. Dealers will ALWAYS want you to take things like GAP insurance and service plans. Again, this is not because they are concerned about your best interests but because they get juicy commissions on all those extra bits. Meanwhile, your costs keep going up but you’re not getting any real benefits.
  • Most importantly, make sure you can comfortably afford whatever you’re spending – with plenty of money left over each month to cover other costs and deal with any problems. If you are up to your eyeballs in debt and have nothing to spare, you are much more vulnerable to any unexpected financial hits that may come your way.

In most cases, this means reining in your ambitions a bit and making sure you’re not biting off more than you can chew. That might be depressing, but your future self will thank me for it.

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.

22 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

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