PCP finance explained: what is equity?

Planning to hand your car back at the end of a PCP contract, but baffled by the concept of equity? Our guide explains all

Christofer Lloyd
May 30, 2020

PCP finance is the most popular way for drivers to fund new cars and it's becoming ever more popular for used car drivers, too. One of the key selling points is the option to hand the car back at the end of the contract or buy it. If you hand the car back so you can finance another one - as most drivers do - you might encounter the concept of 'equity'. 

Equity is the difference between what a car is worth and the remaining amount owed on the finance, typically seen with PCP finance - also known as Personal Contract Purchase. If the car is worth more than the amount left to pay, this is referred to as having equity. Meanwhile, if the finance balance is greater than the car's current value, this is termed being in 'negative equity'. 

PCP is set up so that you should end up with equity at the end of the contract. This means that if you want to go on to finance another car, the one you’re handing back should be worth more than the remaining debt, giving you extra value that you can effectively put towards the deposit on your new car, lowering your monthly payments. This is never guaranteed, though, so it's worth putting some money aside through your finance contract to put towards your next deposit.

Equity occurs when the current value of a car is more than the remaining balance owed on a finance scheme. This happens once the total amount you’ve paid overtakes the amount of value the car has lost since the start of the contract.

Since new cars typically lose value fastest when they’re new, with the rate slowing down as they get older - and PCP features a set monthly payment - drivers are normally in negative equity for most of the contract. This means the remaining debt is greater than the current value of the car for most of the contract, with drivers only potentially ending with any positive equity towards the end.

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).

Get PCP finance on a new car

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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