PCP finance explained: what is equity?

If you intend to give your PCP-financed car back to the lender at the end of the contract, you need to understand equity. Here’s our guide

Christofer Lloyd Matt Rigby
Mar 5, 2021

If you’re financing your new car via Personal Contract Purchase (PCP) then you have the choice of buying the car with a lump sum at the end of the contract or handing it back. Most drivers choose to hand the car back so they can finance a new one – and this is where the idea of ‘equity’ comes in.

At its most basic level, your equity in the car is the difference between what it’s worth at the end of the contract, and the remaining amount owed on finance. If the car is worth more than the amount you have left to pay as the final ‘balloon’ payment on your PCP contract left to pay, this is referred to as having equity in the car. Meanwhile, if the finance balance is greater than the car's current value, this is termed 'negative equity'.

PCP finance agreements are set up so that the user (you) have a car that is worth more than the remaining finance owed at the end of the contract. This means that you effectively have a ready-made deposit to help finance your next car.

There is no guarantee of this, though, so it's worth putting some money aside through your finance contract to put towards your next deposit.

Cars tend to lose their value fastest – to depreciate – when they’re new, and this rate of depreciation then slows as the car gets older. Since PCP contracts are set up with a fixed monthly payment, this means that you could be in negative equity for most of the contract – where the remaining debt is greater than the current value of the car for most of the contract. Drivers can only potentially tip into positive equity towards the end of a contract.

Look at the table of costs below to see how you’re likely to have a substantial amount of negative equity towards the start of a finance contract, with the amount decreasing as the contract progresses, potentially ending with equity (for simplicity these figures assume no deposit and no interest added).

Read our guide to negative equity to understand why it can cause you problems and find out how negative equity finance can help you address the problem of owing more than your car is worth.

Cash price

Value after 1 year

Value after 2 years

Value after 3 years

Optional final payment

£20,000

£15,000

£12,000

£10,000

£9,000

Total amount paid

Value car has lost

Equity

At one year

£3,667

£5,000

-£1,333

At two years

£7,333

£8,000

-£667

At three years

£11,000

£10,000

+£1,000

PCP set up to make equity likely

Most PCP finance schemes are designed so that you should end up with equity at the end of the contract. This is achieved by overestimating how much value the car will lose over the contract term - meaning slightly inflated monthly payments - so the car should be worth more than expected when you hand it back.

In the example above, the car company sets monthly payments assuming that the car would be worth £9,000 after three years, though it expects it to be worth £10,000. If the car is worth £10,000 as predicted, you’d have £1,000 of equity at this stage.

Consequently, if you wanted to hand the car back after three years and step into another PCP deal, you could put that £1,000 towards your next car. An extra £1,000 on a three-year finance deal typically slashes around £30 from your monthly payments. That could mean the difference between paying £306 per month and £278 per month on the example car.

Should you want to hand the car back and walk away, however, you’re unlikely to get this equity back. Don’t worry if you want to finance a car from another manufacturer or dealer, though, as you should be able to 'part exchange' your old car - effectively the dealer pays off the remaining finance and sells the car - and you can still put the equity towards your next car.

Key to having equity is sticking to the pre-agreed mileage limit and looking after the car well, to avoid any charges that would reduce the amount you get back. Remember, too, that if you hand a car back early you’re likely to have less equity or even have negative equity that you’ll have to pay off.

 

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