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Negative equity on a car finance agreement can be a very costly situation. It can happen when the value of the car is less than the amount of money that is owed on the car loan. This can leave the borrower owing more money on the car than the car is worth.
Here we will explain what negative equity is, how and why it happens, and how you can protect yourself against it.
When you take out a car finance agreement, the amount you borrow is normally no more than the invoice price of the car. In most cases, you would have some form of deposit (from a part exchange or cash input) so you would borrow less than the invoice price.
Two figures need to be considered.
The value of most vehicles does decrease over a period of time. Also, as you make monthly payments to your finance agreement your outstanding finance settlement figure will also decrease.
It is the relationship between these two figures that can cause negative equity.
If your finance settlement is higher than the value of the vehicle, then you are in negative equity on your loan.
There are many finance agreements for cars that can have negative equity develop on them. The types of finance are:
A PCP, Lease Purchase, or HP agreement is where you do not own the car until the end of the contract. The finance company retains an interest in the vehicle until you opt to buy it. In some cases, you can hand the car back to the finance company also. The key is that you can own the vehicle. This means that the vehicle is tied to the finance agreement in place.
If negative equity happened on a PCP, Lease Purchase or HP agreement the car would have to be handed back to the finance company and you may still owe money on the car that needs to be paid.
There can be clauses that allow you to bypass the need to pay off the negative equity, including a Guaranteed Future Value balloon payment at the end of a PCP, or termination rights on HP or PCP. More on those later.
In short, GAP Insurance can help you cover negative equity costs in many cases, but not in every circumstance.
If the negative equity has been caused by the current finance agreement on the current car then Gap Insurance should be able to help with this.
There are several ways you can avoid getting into negative equity, or at least minimise the risk.
The key one is to ensure you have a good size deposit in the finance agreement. This is because the deposit will help reduce the overall amount of finance you are borrowing and therefore reduce the negative equity risk.
The bigger the difference between the price of the car and the amount you initially borrow then the less chance you have of negative equity occurring later down the line.
Another way to avoid negative equity is to take a car finance agreement where you can't own the vehicle, or you have a guaranteed value at the end.
For example, a personal contract hire style car leasing is a simple, long-term rental agreement. You cannot buy the vehicle by paying off the lease but you also cannot get into a negative equity situation.
A Personal Contract Purchase agreement provides you with a Guaranteed Future Value at the end. This means if you owe more than the vehicle is worth at that point, then the GFV is there to protect you. PCP car finance is often provided at the motor dealer.
One key feature of hire purchase style agreements, including a PCP new car finance agreement, is the right to terminate the agreement early, with no further payments to make. However, certain criteria must be met in order for you to do this.
Normally, on a PCP or Hire Purchase car finance deal, once you have paid half the total amount payable on the agreement then you can invoke your voluntary termination rights. This means you can hand the car back to the finance company with nothing further to pay.
For example, let's say you buy a car for £10,000, you put in a £500 deposit and you take out a finance agreement for £9,500 over 4 years.
The interest on the loan is £2000 for the 4 years.
This means that the total amount payable on the agreement is £12,000 (£500 deposit, £9,500 from the finance agreement and £2,000 interest).
To get to the point where you can invoke your voluntary termination you need to have paid at least half the total amount payable on the agreement, in this case, £6,000. Remember also that your deposit counts towards that.
Simply if you are in negative equity on the agreement. So if you owe £6,000 and the car is only worth £4,500 then you are in £1,500 negative equity. If you meet the criteria to terminate early then you can the car back and owe nothing more.
Yes, maybe and it depends!
There are a couple of ways in which Gap Insurance could help you with negative equity.
This means you do not borrow more than the vehicle purchase price, and negative equity occurs because the value of the vehicle has decreased quicker than the finance settlement.
In this case, and only when the car is written off by the motor insurer first, Gap protection can help cover the negative equity owed.
Sometimes when you trade in a car, the amount owed on the previous finance agreement is more than the value of your car. You can sometimes arrange to have this negative equity added to the amount you borrow on your new car.
This new finance agreement, therefore, will allow you to buy the new car and pay off the negative equity on your old car in one monthly payment.
What about Gap cover? Well, most standard Gap products will only cover the purchase of the new vehicle, and not the negative equity carried from the old one.
However, some Gap products do provide, either as a stand-alone product or an add-on, Gap cover to include some, or all, of the negative equity carried over. This, of course, can only help if the vehicle is written off, and you owe more on the financial settlement than the value of the car.
If you really don't like the idea of being in negative equity on your outstanding finance is simply to pay it off. You can either pay a lump sum when you buy your new vehicle to clear any shortfall from your trade-in, or to help prevent a situation from developing where you owe more on the financed car than the current market value of that car.
Doing this will also help with lower monthly payments. You will see the biggest benefit on a PCP deal where the balloon payment (the GFV) will not change, but the amount financed will be reduced significantly in many cases. The PCP agreement is one of the most popular in car dealers today, it can help you keep control of your monthly budget when buying a brand new car.
So there we are. Negative equity happens when the settlement figure required by the finance provider is more than the current value of your car. It can be avoided, or you can live with it and protect against it also. We hope our guide has opened your eyes to the options you have available.
How much you will need to pay off the remaining debt will depend on a number of factors. But as described above, there are ways you could protect yourself rather than having to dip into your own pocket.