By Tim Schwarz, Head of Marketing, Moneybarn

Not sure what negative equity means? Vehicle finance provider Moneybarn has put together a helpful guide to help you understand what negative equity means in vehicle finance. Helping to minimise your risk of being affected when you look to sell or trade in your car.

Negative equity is normally associated with homeowners during economic downturns, when their property’s value dips below the amount they still owe on their mortgage.

However, with car finance becoming more popular, motorists can be affected too.

What is negative equity?

Negative equity is a situation in which the amount you owe for something is more than the object’s current value.

For car finance customers, it means the amount owed to the finance company for the vehicle is greater than the car’s current value.

Negative equity on car loans can be common in the first few months of owning a vehicle, as the value of a new car drops the minute you drive off the forecourt. Vehicles can lose up to 40% of their value in the first year.

Selling your car with negative equity

If you’re looking to sell a financed car, it’s always worth speaking to your provider initially because in most cases, you won’t be allowed to sell your vehicle until the full balance of the loan is paid.

However, when the value of the vehicle has fallen below the loan balance, you’ll need to make up the difference out of your own pocket.

For example, you may have taken out a £10,000 loan on a vehicle and after a few months of payments, the balance is £9,000. You then discover the car is now only worth £8,000. This means you’re £1,000 in negative equity on your vehicle.

So, in this case you will need to personally cover the additional £1,000.

Insurance claims

Negative equity can also be an issue if your vehicle is stolen or written off and you claim on your car insurance. Insurers decide how much you should receive based on the market value of the vehicle.

So, in some cases, you could end up receiving a lower sum than the amount you owe to the finance company and you’ll have to make up the difference to the finance provider yourself.

However, if your car isn’t involved in any incidents and you’re able to keep up your repayments until the end of the finance agreement, you shouldn’t be negatively affected, even if you do face negative equity.

How to avoid negative equity

It’s hard to know exactly when something will fall into negative equity, however, there are things you can do to reduce the risk.

For example, paying a larger deposit sum is an effective way to reduce your loan amount. It might also be worth taking out a shorter-term loan so that you can pay more than your agreed monthly payments, getting your negative equity paid off quicker.

Buying a used vehicle instead of a new one can also help, as you’ll see a steeper depreciation curve with a new vehicle.

Finance for negative equity

If you find yourself struggling to make repayments on your vehicle, it could be worth getting in touch with your finance provider to see if they would be willing to restructure your loan.

For example, they may be able to extend your loan agreement to accommodate lower monthly payments over a longer period, to make it more affordable.

As you continue to pay off more of the finance and your vehicle’s depreciation slows, you’re more likely to have positive equity – where the car is worth more than the outstanding finance.