What is negative equity car finance?

Anything with the word ‘negative’ in its name is understandably likely to ring alarm bells, but if you’re one of the many people who find themselves in negative equity with their car finance, don’t panic!
Negative equity is sometimes known as being upside down or underwater on your loan. Essentially, it means that the amount outstanding on your finance is higher than your car’s current market value.
And it’s more common than you might think.
If you end up in negative equity during your loan term, that doesn’t mean you’re stuck. You do have options available, even if you need to urgently change car or need to refinance the loan.
Ready to find out more? Let’s look at the details:

What is negative equity?

In a nutshell, negative equity is the term used to describe owing more money on an asset than the asset is worth. With car finance, it means that your car is currently worth less than the amount still outstanding on the loan.
Imagine you’re three years into a five-year Hire Purchase (HP) agreement and you have £6,000 left to pay. But, when you take your car to be valued at your local dealership, you’re told it’s only worth £4,500. Unfortunately, you have £1,500 of negative equity.
The good news is that negative equity isn’t inevitable. In fact, sometimes your car can be worth more than expected, especially in a Personal Contract Purchase (PCP) finance deal, and you could find yourself in positive equity.

How does negative equity happen?

There are a range of factors that impact your car’s value, but it’s important to know that almost all cars will lose value over time.
While some collectible vintage models might command higher prices as time goes on, most modern cars will get cheaper as they age. This loss of value is known as depreciation, and it happens at different rates.
The rate of depreciation tends to be quickest in the first few years of a car’s life. That means you could get a great deal on a car that’s three or four years old compared to one that’s just rolled off the factory floor.
But what else can lead to negative equity?

Damaging your car

Some wear and tear is expected over the course of your loan but be aware that any damage beyond small scuffs and scratches could impact the car’s value. If you’re involved in an accident and end up with more substantial damage, you could find that you’re now in negative equity.

Making modifications

While some modifications can help your car hold – or even increase – its value, others are more likely to negatively impact its resale value. Installing new safety features is usually a safe bet, but adding a shiny new spoiler, a turbo exhaust, or a distinctive paint colour could all make your wheels less desirable on the used car market.

Overpaying for your car

If you paid over the odds for your car, you’ll have a higher chance of landing in negative equity. There are many reasons why you might have overpaid – and they’re not always your fault! If you bought when market demand was high, you chose a highly sought-after model, or fell victim to an unscrupulous dealer, you might have paid more than the car is worth.

Putting down a small deposit

Don’t have a large pot of savings available or an existing car to part-exchange? We understand that it’s not always possible to put down a big deposit on your car finance. But, while having a strong deposit isn’t always necessary to get a loan, paying less upfront will mean you’ll need to borrow more money and have a higher loan balance.

Having a high interest loan or long term

Whether your credit score could use some TLC or you need to keep your monthly repayments low, you might have a car loan with a high interest rate or long loan term. Unfortunately, this means it’ll take you longer to pay down your debt as you’ll need to pay off more interest. If you need to change car before the loan term ends, you could have an outstanding balance that’s higher than the car’s current value.

Why is it a problem?

In most cases, being in negative equity is temporary and, by the time your loan term comes to its natural end you’ll be back in the black.
But it could become an issue if you need to end your loan term early.
There are many reasons why you might need to change car before your car finance agreement officially ends.
With car finance loan terms lasting between one and six years, a lot can change over that time. Maybe you’ve lost your job and need a cheaper car payment; you’ve had another baby and now need to swap your supermini for a seven-seater; or perhaps you got into an accident and now your car’s been written off.
Unfortunately, changing car and finding a new loan when you’re in negative equity isn’t always easy. But it’s not impossible; negative equity car finance is available.

How can I avoid negative equity?

While there’s no guarantee that you’ll be able to avoid negative equity completely, there are a few steps you can take to improve your peace of mind:

Choose an HP loan

With an HP loan, you borrow the full value of the car while PCP loans only cover the amount of value your car will lose over the loan term. This means you’ll pay off the balance quicker with an HP loan and own more equity in the car in a shorter time.

Buy a car that holds its value well

Some car makes and models are more desirable than others and are known to hold their value well. Consider buying a car from a manufacturer with a reputation for reliability: think Volvo, Mercedes, and Toyota. A universally popular car colour can also help your car hold its value. Choosing a black or silver model could be a better investment than opting for a lime green or neon pink paint job.

Put down a large deposit

The more you can put down upfront, the less money you’ll need to borrow. That means you’ll also own more equity in the car from the outset and have a smaller outstanding balance remaining if you do need to change car before the loan term officially ends.

Keep the car in good condition

Careful drivers may have an advantage when it comes to depreciation. If you keep your car stored safely in a garage, brake and accelerate gently, and make sure to avoid scratching your bumper in that tight multi storey car park, you’ll increase your chances of getting a good price for your wheels on the used car market.

Keep mileage low

Driving long distances and putting a lot of miles on the clock is more likely to lead your car parts to get damaged or worn. Used cars with a low mileage are also more desirable to prospective buyers.

How can I get out of negative equity car finance?

Sometimes you can take all the possible precautions and still end up in negative equity. Don’t panic; there are four main options available to you:

Do nothing

If you don’t need to change car urgently and can wait until your loan term comes to its natural end, you can simply carry on as you are. Keep making your monthly payments until you either become the car’s legal owner (if you have an HP deal) or can hand the car back and walk away if you have a PCP loan.

Request voluntary termination

If you can’t afford to keep making payments and would rather give up your car, you have the right to request voluntary termination. Voluntary termination is a legal right set out under Section 99 of the Consumer Credit Act 1974 that allows you to end your loan and hand the car back to your lender at any point. You just need to tell the lender you want to voluntarily terminate and return the car.
It’s important to note you’ll need to pay 50% of the total amount payable (including the balloon payment in a PCP). If you’ve made some payments, but not yet reached this point, you’ll need to pay the difference. If you’ve already paid over 50%, you can return the car without needing to pay any more money.
Extra charges might apply if the car is damaged beyond fair wear and tear.

Settle the negative equity

There’s nothing stopping you paying out of pocket to make up the difference between your outstanding loan and the car’s value if you have the savings ready to go. You can do this by paying the settlement figure (that’s the amount you need to pay to end your car finance agreement early) or pay the dealer who is handling your part-exchange directly and they can then settle the finance on your behalf.

Get negative equity car finance

If you’d like to change car before the end of your loan term and get a new model on finance, you might be eligible for negative equity car finance. This is a type of finance that rolls your negative equity and the cost of buying a new car into one monthly repayment. Choosing a cheaper car could help you reduce your repayment amount or help you reduce your loan term when you refinance.

Can I get car finance if I have negative equity?

Having negative equity doesn’t mean you can’t get a new car on finance – that’s where negative equity car finance can help!  
This is a type of finance agreement that combines both the cost of your negative equity and your new car into one monthly payment.
Eligibility criteria will apply, and you’ll likely have to undergo checks including a hard credit check. You’ll also need to show that you can afford your new combined repayment.
If you have limited disposable income, choosing a cheaper car or a longer loan term could improve your chances of securing a negative equity finance deal.

FAQs about negative equity:

What is the best way to deal with negative equity?

If you find yourself in negative equity, the best next step for you will depend on your personal priorities and financial circumstances.
With a healthy savings account, you might feel more comfortable covering the negative equity and settling your finance yourself. Alternatively, if you don’t need to change car urgently, you could decide to continue making payments until your loan term naturally comes to an end.
On the other hand, if you’re struggling to make payments or need a new set of wheels as soon as possible, voluntary termination or a negative equity car finance agreement might be a better fit.
It’s worth weighing up the pros and cons of each option to ensure you choose the way forward that will work best for you.

Is there a difference between HP vs PCP negative equity?

While HP and PCP loans are similar in many ways, they do have differences when you find yourself in negative equity.
Firstly, you’re more likely to end up in negative equity if you have a PCP loan. That’s because you don’t need to borrow the full purchase price of your car and so won’t own as much equity in it over time as you would if you had an HP agreement.
You’ll also have to consider your options if you’re in negative equity when your PCP agreement ends. If your car is worth less than the balloon payment, you might be better off returning it to the lender rather than paying over the odds to become its legal owner.

Can I part exchange my car with negative equity?

Negative equity can make part exchanging a car a little more complicated, but it’s not impossible.
With both an HP and PCP agreement, you’ll need to settle your finance first. You won’t be the car’s legal owner until the finance is settled and it’s officially all yours.
In negative equity, the settlement figure will be higher than the car’s value. If you have savings, you could pay the difference, take the loss, and then part exchange the car as usual.
However, if you’re relying on a dealership to handle the settlement on your behalf, you’ll likely need to pay them the difference so that they’ll agree to take the car off your hands.

Will putting down a larger deposit reduce my chances of negative equity? 

Deposits aren’t essential in car finance, but they can help you reduce your likelihood of landing in negative equity. It’s all about the maths; the more you put down, the less you’ll need to borrow. You’ll own more equity in the car from the start of your agreement and may be able to pay down the balance faster if the lower loan amount allows you to have a shorter agreement term.