PCP finance explained: what is equity?

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

Christofer Lloyd
May 29, 2019

Equity is the difference between a car’s value and the remaining amount owed at any moment in time, typically seen with Personal Contract Purchase (PCP) finance.

A vast proportion of new cars - and an increasing number of used cars - are now purchased via PCP.

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 cash in and put towards the deposit on your new car, lowering your monthly payments.

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, 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 positive equity (for simplicity 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 it 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 expected, 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 is likely to slash £28 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.

             

Read more about:

Latest jargon busters

  1. What is voice control?

  2. What is a full service history?

  3. No credit history? How to build one and secure car finance

What our customers say