Equity: Car Finance Jargon Busters
Are you planning on financing a car? If so, you need a good grasp of what car finance equity is. It’s one of the terms that car buyers must understand 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! 😀
What is equity in car finance?
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 known as having equity in the car.
On the other hand, if the car's value is less than the amount you still owe the car finance company, then that’s what’s called having negative equity.
What is negative equity?
As mentioned earlier, negative equity is when the car's value is less than the amount you still owe the car finance company.
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.
If you ever part-exchange the car or sell it, then the money you’ll get won’t be enough to cover your owed 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.
What causes a car to have negative equity?
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, 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 took out a finance agreement with a longer contract term, say four years or more.
Car Finance Equity in PCP Deals
With a Personal Contract Purchase agreement, you can buy the car at the end of your car finance contract by paying the optional balloon payment. You may also 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 hand back the car to the car finance company to use its equity 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 keep equity in your car.
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 course, even if this is the usual case for PCP deals, it’s not guaranteed.
It’s still important to know what the actual value of the car is and compare it to the final payment or value to carry forward.
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 your contract, 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.
What if I can't pay for a car in negative equity?
Another thing to watch out for is changes in your financial situation. 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.
It’s crucial to be always ready in case your circumstances change, such as job loss, divorce, medical emergencies, and other issues that could impact your finances. Some of these situations may cause drivers to struggle with keeping up with their car finance repayments.
What do I do if my car is in negative equity?
If the car is in negative equity and you're having trouble making payments, contact your lender immediately. Explain your situation and request if it's possible to revisit your contract to see if there's a way to make payments more affordable.
With a car 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.
It's really important to communicate with the car finance company if you’re having trouble making payments. Ignoring their notices will lead to them taking the necessary legal actions to get their money back, and your debt will only increase.
Before signing any car finance deal, carefully examine 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 you can comfortably afford the purchase and have enough cash for a deposit, monthly repayments, insurance, and other ongoing car-related expenses.
Financing a car is a big financial commitment. If you want to get an estimate of how much it will cost to finance a car, you can use our car finance calculator.