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 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 starts to slow down and your repayments start to ‘catch up’. But on a PCP, it is still possible that you will never completely 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. These 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 will 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 result in you 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, the car is worth less than it should be and you have a larger problem.
- Make overpayments if you can. 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 the total amount of interest you will have to pay) 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 necessarily 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 repayments 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 sound depressing now, but your future self will thank me for it.
This article was originally published in March 2017, and was last updated in August 2020.