Equity in car finance can either be positive or negative, depending on whether your car’s value exceeds or falls short of your outstanding loans. In the UK, most car financing agreements are structured so that you start and remain in ‘negative equity’ for at least half of the contract duration.

The equity of your vehicle fluctuates over time due to factors such as depreciation of your car’s value, loan repayments, and global market condition. Initially, car values depreciate after purchase, but this depreciation typically slows over time, allowing your loan payments to catch up and resulting in positive equity.

Positive equity can be advantageous when selling your car, as the car’s value exceeds the outstanding finance amount, enabling you to pocket the surplus funds. Conversely, if your car’s depreciation outpaces your loan payments leaving you owing more than the car’s value, you remain in negative equity. This situation can limit your ability to sell or trade in the vehicle without incurring financial losses, potentially leaving you owing money even after selling the car.

While negative equity may restrict the feasibility of upgrading to a new vehicle, understanding the changing value of your financed car empowers you to make informed decisions about when to sell, ultimately maximising the value you receive.

What is a Guaranteed Minimum Future Value?

When you engage in a PCP car financing agreement, your finance company commits to a predetermined value for your car at the end of the payment period, regardless of its actual market worth at that time. This predetermined value, considering factors like mileage and condition, is referred to as your Guaranteed Minimum Future Value (GMFV), also known as Guaranteed Future Value, balloon payment, or optional final payment.

The GMFV offers a level of assurance for both buyers and finance companies. For buyers, it provides insight into the car’s future value, facilitating budgeting. At the end of the contract, buyers have the option to purchase the car outright by settling the GMFV. For finance providers, the GMFV helps mitigate depreciation risk and ensures the recovery of funds at the contract’s conclusion.

Nevertheless, it’s important for buyers to grasp the terms and conditions associated with the GMFV, including mileage restrictions, maintenance obligations, and charges for wear and tear. Additionally, it’s crucial to recognise that the GMFV might not accurately represent the actual market value of the car at the contract’s conclusion. If the vehicle’s value surpasses the GMFV, buyers can utilise the equity towards their next purchase. Conversely, if the car’s value falls below the GMFV, buyers have the option to return the vehicle.

What affects equity?

Various factors influence the value you derive from your car financing agreement, akin to the value of your vehicle itself. A lower car valuation coupled with higher interest rates diminishes the overall value you receive.

1. Car depreciation :  All vehicles depreciate over time, albeit at varying rates. Rapid depreciation early on may result in the outstanding loan balance exceeding the car’s depreciated value, complicating efforts to escape negative equity. Monitoring your car’s fluctuating value enables informed decisions on when to sell.
2. Financing terms : Carefully review your financing agreement. Lengthier loan terms with lower repayments translate to a slower reduction in the principal amount owed, potentially leaving you more than your car’s value.
3. Interest rates : Elevated interest rates lead to substantial interest accrual, prolonging the time to required to pay off the principal loan amount.
4. Inadequate deposit : A small initial payment leads to a higher loan balance, extending the duration of negative equity.
5. Debt rollover : Transferring balances from prior loans to a new one can exacerbate negative equity, hindering catching up to the car’s value.
6. Market fluctuations : Economic and automotive market shifts affect your car’s value and financing terms, influencing equity and valuation.

Avoid negative equity

• Valuation : The quicker your car’s value drops, the greater the risk of being stuck in negative equity. Factors like mileage and condition, which you can control, contribute to depreciation. Prioritise reputable car brands and models recognised for holding their value when making a purchase.
• Financing agreements : Opting for a longer-term financing plan to lower monthly payments may result in paying more in the long run due to compound interest. Shorter loan terms expedite principal repayment, reducing time spent in negative equity. Maintaining a good credit score can facilitate securing favourable interest rates.
• Repayments : Boosting monthly payments or making overpayments when possible is the most effective way to shift into neutral or positive. This approach allows you to pay of the debt and its compounding interest faster than the car depreciates in value. It aligns your car’s worth with the outstanding loan and decreases the total payment period.

Managing negative equity

1. Settle negative equity upfront : If financially feasible, consider paying off your outstanding loan balance, especially the amount surpassing your car’s current market value. By proactively closing the equity deficit, you eliminate negative equity and realign your loan balance with your car’s value.
2. Refinance and incorporate negative equity into a new loan : Investigate refinancing opportunities to merge the shortfall into a new finance agreement. Although this extends your monthly payments’ duration, it offers immediate finance relief by integrating negative equity into a fresh arrangement.
3. Opt for private sale : Selling your car privately can be a strategic step to mitigate financial losses. Private sales often yield higher prices compared to part-exchanges, assisting in bridging the financial disparity between your outstanding loan and the car’s market value.