In car finance terms, negative equity is when your car is worth less than your outstanding finance.
If you wish to sell the car during your finance agreement, and the vehicle is worth less than the amount owed, you’ll need to cover the shortfall.
To explain how negative equity works in more detail, let’s take an example.
Imagine you take out car finance on a 36-month agreement for a brand-new car valued at £20,000 at an interest rate of 9.6% APR.
Your total amount payable with interest is £22,963.50, and your monthly cost is £637.87.
Within one month of driving away from the forecourt, your car has Depreciated by 10% and its current market value is now £18,000.
At this stage, you have only paid one monthly instalment of £637.87, so your outstanding finance is £22,325.63.
This leaves you with a negative equity of £4,325.63. But don’t worry - this is normal during the early stages of a car finance agreement.
Especially with a brand new vehicle, as it depreciates at a faster rate than a Used Car.
When you have paid off more of the finance and the depreciation has slowed, you’re much more likely to have positive equity, whereby the car is worth more than the outstanding finance.
If you’re in negative equity and your car is written off or stolen, your insurer will only pay out the current market value of the vehicle at the time of the incident.
This means you would need to cover the shortfall between the insurance pay out and the outstanding finance.
Negative equity may also be a problem if you wish to end your contract early.
Voluntary termination gives you the right to walk away from the agreement, but only available if you have repaid at least 50% of the total finance package.
With PCP you have 3 options at the end of your contract. You can either return your vehicle, pay a balloon payment and keep the vehicle, or part-exchange it for a newer model.
However, you can only part-exchange your car if you have positive equity (the car is worth more than the GFV).
Negative equity can be costly, but don’t worry, there are several ways to protect yourself and mitigate the risk.
Paying a larger deposit is an effective way to reduce your loan amount. Typically, the smaller your loan amount, the less likely you are to fall into negative equity.
However, by opting for a used or nearly new car, the depreciation rate is more likely to keep pace with the outstanding finance.
You can end a PCP agreement early, if you have already repaid more than half the finance amount – including interest and fees.
If you haven’t repaid 50% of the finance, you can still end the agreement early by paying the difference.
With PCP, one way to mitigate the risk of additional charges is to stay within your Annual Mileage Limit and keep the vehicle within the acceptable return conditions.
GAP Insurance will help to protect you if your car is financed and is stolen or written off in an accident.
While standard insurance policies only cover the value of the vehicle at the time of the incident, GAP insurance will pay the shortfall between the value of the car and your outstanding finance.
Alternatively you can opt for RTI GAP. This covers you for either; the difference between the value of the car at the time of the incident and the original purchase price, or the difference between the value of the car at the time of the incident and your outstanding finance, whichever is greatest.
Check your eligibility today without affecting your credit score and receive an instant decision.