Trading in a car with negative equity

It is possible to end up with a car with negative equity during a finance plan. We explain what it is and how to handle it...

Quick guide to car finance

If you’ve bought a car with finance then it is possible to enter negative equity during the contract or at the end of it. This means that the car is worth less than the amount of money you have to pay back. If, for example, you have £5000 of the loan remaining, but the car is worth £4000, it is in £1000 of negative equity.

Why does negative equity happen?

The exact reason that a car enters negative equity can vary, but it essentially means that it has depreciated faster than was originally anticipated.

A huge number of factors can affect what a car is worth; condition, age and mileage are three of the obvious ones, but wider elements such as the economy and the strength of the used car market can also have a huge influence.  

Negative equity is more common with longer finance contracts, because a car’s value is harder to predict over a longer period of time.

The easiest way for new car buyers to reduce exposure to negative equity is to ensure they get a good deal on their car in the first place. This means the difference between the new car value and its expected value at the end of the loan is less, leaving them in a better place. To achieve this without the hassle of haggling, you can simply visit What Car?'s New Car Buying service.

What does it mean if my car is in negative equity?

If you buy a car on finance, then it will almost certainly enter negative equity at the start of the loan. This isn’t anything to worry about; new cars depreciate very quickly initially and so it’s expected that they will experience negative equity early on.

Over time, the depreciation slows down and the monthly payments and the equity level off. Most conventional car buyers are left with some equity in the car at the end of their finance contract.

However, even if you're not, if you bought the car with a personal contract purchase (PCP) loan, then you don’t have to worry about negative equity. PCPs are arranged with a guaranteed future value for the car, which means the finance company agrees how much the car will be worth at the end of the term when the loan is first arranged.

If they get it wrong, they take the hit, providing you stick to pre-agreed parameters, such the mileage limit, and keep the car in good condition.

Lady signing car finance agreement in a showroom

Similarly, if you bought the car via another form of finance and it ends up in negative equity, there's nothing to worry about if you don’t intend to take out another loan; as long as the car is in good condition and within the agreed mileage limit, the loss is with the finance company, so you can simply return it.

However, if you planned to use the car’s remaining value as a deposit towards your next contract, then negative equity is more of a problem, because you’ll need to fund the next deposit yourself.

Changing contracts with negative equity

It is not uncommon for customers to change from one finance deal to another before the end of their existing contract. In fact, dealers often encourage it; they use software to track the status of contracts and will frequently contact you in advance to offer you a new car early if it’s possible to do so at minimal or no additional monthly cost. This can mean you end up with a new car sooner than you expected but there’s also a big benefit for the dealer, as it keeps you signed up with them for longer.

It’s important to understand whether or not your car is in negative equity, though, and if that will affect your payments before you decide to change. If it’s not, then that’s no problem and any positive equity you have can be used to reduce your monthly repayments on the next loan.

On the other hand, if the car is in negative equity and you transfer to a new one, then, depending on the type of finance, you may end up transferring the existing negative equity to the new contract. This will be added to the loan and increase the monthly payments. The finance company should be clear with you about this, but make sure you are as well and don’t be afraid to ask if you’re in doubt.   

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