Negative equity: What is it and what can I do about it?
Car finance is becoming more popular than ever and more people are choosing to finance their car with some sort of credit. New cars these days can be very expensive and car finance enables you to spread the cost of your next car into affordable monthly payments. One of the biggest things that can put people off are the words “negative equity” and there is a common misconception that having a car on finance means that you automatically get negative equity. However, this isn’t always the case. UK Car Finance explain what negative equity is, why you have it and how can you avoid it.
What is negative equity?
When you take out a car finance deal, you are loaning of the amount for your desired car from a lender. You then pay back the amount you owe in monthly instalments. Negative equity is when the value of your car is less than the amount you need to settle your finance agreement. For example, if your car is worth £5,000 but you owe £7,000 on the finance, you would have £2,000 negative equity let at the end of your deal. Of course, if your car is worth more than you owe, your equity would be a positive number and referred to as ‘equity’.
How do I have negative equity?
Negative equity can be caused by a number of factors. It is usually caused when a car loses its value or depreciates faster than expected. Naturally, some cars depreciate faster than others. Choosing a car which depreciates slower can save you money in the long run and reduce the chances of negative equity.
Negative equity can also become a big problem when your circumstances change unexpectedly, and you may find yourself in a position where you can’t afford to make your monthly payments anymore. The unexpected loss of a steady income can seriously affect your ability to meet payment deadlines. If you’re worried about how much you can afford for car finance, you can use an online car finance calculator to work out your likely loan amount even before you apply.
The length of your contract can also affect your chances of having negative equity. If you have a high-interest rate or the term length was too long. Longer terms are attractive as they usually have a lower monthly payment, however, by the time your finance agreement is finished, your car more than likely won’t be worth much at all or it may not have lasted the lifespan of your deal.
Will I always have negative equity when I take out car finance?
Not necessarily no. It’s a common misconception that any sort of car finance leaves you with negative equity. However, this isn’t always the case. Negative equity is often associated with Personal Contract Purchase, where you will more than likely have negative equity all the way through your agreement until the end. Usually negative equity is less of a problem with hire purchase car finance deals due to the monthly payment typically being higher, which means you are paying off more of the car each month.
How do I avoid negative equity?
In some cases, you may not be able to avoid negative equity however there are ways in which you can reduce the risk of negative equity.
- Put down a bigger deposit. The more you put in for a deposit means the less you will pay in the long run and also may reduce your interest rate as you are borrowing less money.
- Choose a shorter term. When your term is reduced you usually pay more each month; however, this can help you avoid or minimise the amount of negative equity you have as you are paying off the balance of the car faster.
- Be realistic with your mileage. Your finance deal is calculated with your annual mileage in mind. Having a smaller mileage may make your payments cheaper but it may sting you in the long run. When you give the car back at the end of the deal, the dealership expects it in perfect condition and within the agreed mileage. Additional mileage could land you with a penalty fee.
- Check your affordability. One of the biggest risks of negative equity is missed payments. The more often you miss payments, the more money you owe on your vehicle. It also has a damaging effect on your credit score and can reduce the likelihood of you being accepted for finance in the future.
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