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Equity: Car Finance Jargon Busters

Are you planning on getting a Personal Contract Purchase car finance deal? If so, it’s important that you get a good grasp of what car finance equity is. It’s one of the terms that car buyers need to understand first before agreeing and signing a contract with a car finance company. If you’re ready for a car finance jargon crash course on this topic, let’s jump right in! 😀

Car Finance Equity in PCP Deals

With a Personal Contract Purchase agreement, you have the option to buy the car at the end of your car finance contract by paying the optional balloon payment. You may also choose to return the vehicle if you don’t want to own it. It’s a very flexible car finance deal that many UK drivers opt for. 

Many drivers choose to hand back the car to the car finance company so that they can use this as a deposit to finance another vehicle. If this is what you’re planning to do when your contract ends, then it’s important to know more about what car finance equity is. 

What is Equity in Car Finance?

Basically, a car’s equity is the difference between the vehicle’s worth by the end of your contract and the amount you still owe the lender. If the vehicle’s value is worth more than what you still have to pay for your balloon payment, this is what’s known as having equity in the car. On the other hand, if the value of the car is less than the amount you still owe the car finance company, then that’s what’s called having negative equity. 

How PCP Agreements Work

PCP deals are designed in such a way that you, the borrower, will have a vehicle that’s worth more than the amount you owe the car finance company by the time your contract ends. It’s like this so that you’ll have a deposit ready if you ever choose to finance a new car when you’re done with your current PCP agreement. Of you can pay the balloon payment and own the car outright. Of course, even if this is the usual case for PCP deals, it’s not a guarantee, so it’s still important to know what the actually value of the car is, and compare it to the final payment or value to carry forward. 

Negative Equity: What to Do About It

As mentioned earlier, negative equity is when the value of the car is less than the amount you still owe the car finance company. If you ever part-exchange the car or sell it, then the money you’ll get out of it won’t be enough to cover your finance so you’d have to use some of your savings to pay the difference. This isn’t a good scenario because if the car has equity, you won’t have to take out cash from your savings so you can finance a new car. 

Here’s an example, say the current finance settlement amount is £16,000 but the current value of the vehicle is just £12,000. That means it has a £4,000 negative equity. But why does this happen in some cases? Typically, when the car depreciates or loses value faster than the rate with which you pay your car finance repayments, then it’s most likely to be in negative equity. 

In Personal Contract Purchase agreements though, this happens at the start of your contract and it’s normal, so don’t worry about it. However, if the car still has negative equity and you’re about to finish your contract, then it’s time to consider returning the vehicle to the car finance company. Apart from the car losing its value fast, there could be negative equity if you only paid a small deposit or if you’ve taken out a finance agreement with a longer contract term, say four years or more.   

Should I Worry About Negative Equity?

At the beginning of your PCP contract, it’s normal to have negative equity in the car because you’re only starting to repay the loan. However, if this continues throughout the duration of your contract, then it would be wise to do something about it, such as returning the vehicle to the car finance company before the negative equity gets bigger.

Another thing to watch out for is changes in your financial situation. It’s crucial to be always ready in case your circumstances change, maybe events such as job loss, divorce, medical emergencies, and other issues, where this could definitely impact your finances. Some of these situations may cause drivers to have problems when it comes to keeping up with their car finance repayments. If the car is in negative equity, selling or part-exchanging it won’t be enough and you would still owe money to the car finance company. 

This situation could lead to you defaulting on your car finance agreement. You will be charged late fees and other penalties on top of the amount you have to pay. Ultimately, your debt gets bigger and your situation becomes worse. If you cannot pay or find a way to request a new repayment scheme from the lender, then they will hand your account over to a collections agency. There it's really important to communicate with the car finance company if you’re having trouble. Ignoring their notices will just lead to them taking the necessary legal actions for them to get their money back and your debt will only increase. 

Takeaway

Before signing any car finance deal, it’s crucial to know and be certain about whether you can afford it or not. Remember that a car finance agreement will last for a few years and you have to repay the lender a fixed amount every month. You need to be sure that you can comfortable afford the purchase and have enough cash for a deposit, the monthly repayments, insurance, and other ongoing car-related expenses. 

When getting a PCP deal, ensure that you understand the contract fully. If there are any details or terms that are vague to you, do ask the car finance company’s representatives. They will be more than happy to guide you through the agreement line by line. A car finance contract is a big financial commitment. Minimise the risks, such as the chances of the car being in negative equity, by making sure you’re always on top of your monthly repayments as defaulting can have a major effect on your future credit score. 

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