Negative equity car finance?

Negative equity car finance

If you can’t settle your current finance deal but need to change your car, then negative equity finance could be the solution for you.

If your car is worth less than the amount left outstanding on your finance deal, then you’re in negative equity. Most of the time this isn’t a problem, because usually the value of the car and the amount you have to pay converges over time. But if you want to refinance or settle your contract early, it could prove an issue.

Those on a Personal Contract Purchase (PCP) deal will likely find themselves in negative equity for most of the length of the agreement, due to the way this particular finance model works – cars generally depreciate faster than you pay off your balance. Only at the end of the contract, when depreciation slows, does the total amount of monthly payments, plus your deposit, catch up.

Let’s say that you’re one year into paying your monthly instalments on a PCP deal. Your car is now worth £10,000, but the early settlement figure on the finance – how much you’d need to pay to end the deal and own the car – is £12,000. That would mean a negative equity value of £2000 – even if you gave the car back early, you’d still owe the finance provider £2000.

This can be a problem if you’re struggling to afford your payments and need to hand the car back, or switch to a different, cheaper car. That’s where negative equity finance comes in – a process designed for these situations.

Essentially, it means the outstanding debt from the original finance deal is brought into a new deal on another car. You pay one monthly payment that covers both the new car and the balance (or outstanding fees) left on your old car.

What is negative equity finance?

This type of finance lets you pay for a new car and repay extra costs from a previous finance deal, all in one set of monthly payments. You can use negative equity finance to reduce your monthly outgoings (as long as you choose a cheap enough new car) or upgrade to another car early.

You start by choosing a less expensive car than the one you have. It can be either new or used car. You then take out a finance deal on the new car with a lower monthly payment, and trade your other car in. Your new monthly fee will cover both the new car and the extra owed on the old car in negative equity.

As long as your new car is a fair amount cheaper than the old one, you should be paying less overall than if you had simply continued with the old contract.

If you’re struggling to make your existing finance payments, then negative equity finance isn’t the only way forward. It’s always worth talking to your lender to see what other ways they can help, and we’ll look at some other options later on.

If you’re using negative equity to buy a car better suited to your needs, rather than because you’re struggling to make payments, then you may end up paying more than before. For example, if you suddenly have triplets in the family and need extra seating, you may have to get a larger, more expensive car that costs extra per month, especially when you factor in the negative equity costs from your previous car.

How negative equity finance payments are calculated

When you cancel a finance agreement, the difference between the car’s value and the amount you still owe is calculated.

You then take out a new finance deal that adds that difference onto the total amount paid for a new car. Everything is then paid at once over a series of new monthly payments.

Negative equity loans with PCP car finance

Most negative equity finance covers the early settlement fees of PCP agreements. These are particularly susceptible to negative equity situations, because your monthly payments only pay off the depreciation of the car rather than its full value, meaning more of the car’s value is owed.

Once you find a replacement car, you can arrange your negative equity finance and your current car will be collected. Your new finance provider will then settle the outstanding amount from your old deal, and you’ll have a new schedule of monthly payments to cover the new car and any outstanding balance and/or fees from your old contract.

This system could also help if you’re returning the car at the end of PCP contract and have penalties incurred from exceeding the mileage limit or damaging the vehicle. Should you be unable to afford these fees, negative equity finance can settle them and get you into another car.

Negative equity loans with Hire Purchase car finance

Cars financed through Hire Purchase are less at risk of negative equity. This is because each month you’re paying off the balance of the whole car, which is faster than with a PCP deal that only pays off the car’s depreciation.

It’s not impossible to find yourself in negative equity, however, particularly early in the contract. If you do need to cancel your Hire Purchase deal then you should be able to finance a cheaper car through a new negative equity agreement.

Negative equity loans with car leasing

It can be trickier (and more expensive) to end a car lease deal early than with a PCP or HP agreement, because you’ll have fewer legal rights as a consumer. Often, your ability to end the deal early will depend on the decision of the leasing company.

It can often be cheaper to just continue with the lease, because you’ve signed a contract to make all the payments, even if you give the car back. However, negative equity finance could work for you if you need to cover early termination fees or excess mileage or damage charges on your outgoing car while also covering a new car on a PCP or Hire Purchase deal.

If you’re worried that you might face issues affording your monthly payments, it’s best to avoid leasing entirely, because PCP and HP deals will give your more flexibility if your circumstances change.

Negative equity finance alternatives

Negative equity loans aren’t the only option if you’re having trouble making your monthly payments. Your first course of action should always be to speak to the lender and explain your situation, as they may be able to help. They may be able to offer a new payment plan that’s more affordable, possibly spreading your payments over a longer period to reduce the monthly amounts, or moving to a different type of finance.

Alternative options include refinancing at a lower rate or over a longer term. This could include extra costs – settlement fees are common when refinancing, and if your new deal is over a longer term then you could be paying more overall in interest. However, if it means lower monthly payment then it could be an attractive option.

Voluntary Termination is a legal device on PCP or Hire Purchase deals. If you’re already paid half of the total amount payable, including deposits, monthly payments and optional final payments on PCP agreements, then you can voluntarily terminate the finance contract by handing the car back. There’ll be nothing else to pay, but you’ll have nothing to show for your payments and it could make it more difficult to get the finance deals in the future.