What Is Equity in Car Finance?

Equity is a concept you should be familiar with if you have a financed car and are paying off the loan. It's the gap between the amount you owe on the car and the vehicle's current market value.

If you're looking for ways to finance a car, this article will help you learn everything you need to know about car finance equity.

What Is Equity in a Car Loan?

Equity in a car loan is the value difference between what your car is worth and what you still owe, just like with a mortgage. The entire amount you owe the finance provider at the start of your plan will be made up of the amount you're borrowing, the interest on the loan amount, and any payable.

When describing car finance, the phrase "equity" refers to the difference between the vehicle's selling value and the balance still owed to the lender.

How Car Equity Loans Work

If you apply for a car equity loan, your lender will base their offer on the amount of equity you have in your vehicle. If you still owe money on your loan, your equity will be the current market value of the car minus the outstanding balance of your loan.

For instance, if the car is worth £15,000 and you owe £5,000 on it, your equity is £10,000 (£15,000 - £5,000).

However, the maximum amount you can borrow is governed by each lender's specific rules.

Early Settlement and Equity

To terminate your car loan early, you'll need to pay a settlement figure generated by the lender based on your existing debt.

If your car has positive equity, meaning that its residual value is greater than the settlement amount, you can use the sale proceeds to pay down the settlement amount. If your vehicle has negative equity, if its residual value is less than the settlement sum—you will be responsible for covering the difference.

Equity Types

The following section explains in detail the different car finance equity types:

Positive equity

If your car is worth more than the finance issuer anticipated it would be at the end of the finance agreement, you are said to be in positive equity. This is typical because providers frequently employ a "worst-case scenario" pricing methodology when estimating the future worth of their vehicles on PCP.

When using PCP (Personal Contract Purchase) finance, it's critical to understand your equity position to decide the best course of action when your contract ends.

What do you do if your car has positive equity?

If your equity is positive, you can put the extra cash toward the down payment for your next car.

Negative equity

Negative equity car finance occurs when the car's value at the end of the contract is lower than the GMFV (Guaranteed Minimum Future Value, sometimes referred to as the "balloon payment").

What do you do if your car has negative equity?

The lender will take the hit if you want to hand the car back and leave. However, if you're going to become the owner of your vehicle, you'll have to pay off the remaining finance.

If you can't afford to pay off the entire balance of your car loan at once, you can refinance it.

Car Loan Equity Example Table

Observe the table of costs below to show how you're likely to have a considerable amount of negative equity at the start of a financial contract, with the amount diminishing as the contract goes on, possibly ending with equity.

Overview of PCP Car Finance Equity

Three repayment options are available at the end of a PCP contract, making it a solid car finance choice for consumers.

You can either make a balloon payment and keep the car, trade it in for a newer model or give it back to the lender.

Even if your car's GFV (estimated final value) is lower than its resale value, you can still use the equity you've accrued toward your next PCP finance deal.

PCP is designed to make equity likely

Most PCP finance schemes end with equity. This is done by overestimating the value the vehicle will lose throughout the contract, which means inflated monthly payments, so the car should be worth more when you hand it back.

How Do You Calculate the Equity in a Car?

To calculate the equity in a car, visit your car lender's website to see the number of payments you've made, the number left on your loan period, and the amount you owe on the vehicle.

All cars lose value with age, and many factors affect how much a car is worth. Popular car models will maintain their resale value better than less popular ones. High mileage lowers the resale value, whereas low mileage can be of benefit. Even after repairs, an accident might impair a car's market value. Some accidents cause total loss, decreasing the car's value to zero (other than its value as scrap metal and for spare parts).

Many car dealers offer free assessments based on current market conditions.

Example: Consider financing a £20,000 one-year-old used car. Your trade-in and down payment amounted to £4,000, so your car loan is £16,000. At 4.5 % interest and a 48-month repayment period, your monthly payments will be slightly under £365, and you'll pay over £17,513. If you pay off the loan early, you'll pay less, but let's say you make the minimum payment for four years.

On the day you take ownership of the car, your £4,000 trade-in and down payment will provide you with £2,487 in equity, or 12.4% of how much the car is worth before you make the payment.

After 24 months and 24 payments, you'll have paid just under £8,757 and owe the same amount. The car will be three years old, and you'll have mileage, dings, and scrapes, so its resale value will be less than you paid.

Your car's condition and mileage will determine its real value but predict a 10% yearly reduction in resale value. Suppose your £20,000 car is worth £16,000 after two years. Your equity is £16,000 less the loan balance (£8,757), or £7,243—just over 45% of the car's market value.

At the end of the contract, when you owe nothing more, your equity is 100% of the car's resale value.

How Can I Use My Car's Equity?

If your car has negative equity, ask your lender for better loan terms. You can also pay off the debt quickly to avoid wasting money. Since the lender owns the vehicle, they'll keep whatever you get for it, and you'll still repay the rest of the loan.

If you have positive equity in your vehicle, you may be able to refinance your old car or use it as collateral for a personal loan after a year or two. The lender could repossess the car if you use your vehicle as collateral and don't make payments.

Let's Wrap This Up

Before signing a PCP loan agreement, hunt for an excellent offer to avoid negative equity, by minimising the difference between the current value and GMFV, you reduce the danger of the car being worth less than the final payment.

Want to learn more about car finance? Visit our guides page to get started. Carplus simplifies car finance in the UK. Our car finance calculator helps you switch cars. Just input a few details to get started, and we'll take care of the rest.