Steer clear of car finance deals that look cheap because of low monthly repayments. You could end up in the motorists' version of negative equity: a car worth less than you owe.
Many motorists have been stung by the negative equity trap over the past year as car prices have plummeted. The risk was worsened by the proliferation of car finance deals offering low deposits, deferred payments or long repayment periods. The less the debt paid off, the bigger the potential difficulties when car owners want to trade up or sell.
An index of car prices set in July 1999 by Alliance & Leicester bank and What Car? magazine shows that new car prices fell, on average, by 10.4 per cent over 18 months to the end of 2000. Prices for used cars (three-year-old vehicles) fell by an average of 4.5 per cent over that period, although that figure represents the begin ning of a recovery in used car prices towards the end of last year. Between August 1999 and August 2000 prices fell by 21.7 per cent on average.
A&L spokesman Geoff Seymour says: 'It was at that point that people were finding themselves in negative equity. They hadn't got the value in the car any more.'
Some of the worst affected cars have been 'people carriers' such as the Renault Scenic, Ford Galaxy and Vauxhall Frontera.
CAP Motor Research, which publishes guides to car prices, says negative equity has been a particular problem for people who bought on traditional hire-purchase agreements. If you have a personal loan from a bank, you own the car from the outset, and although you may get less for the car than you owe, at least you can sell.
With hire-purchase you do not own the car until the loan has been repaid. Buyers who wanted to swap to a new car part-way through a deal would normally expect to get back enough to repay their existing finance and put down a deposit on another car. But in the recent market, trading up has not been an option.
Simon Goldtharp, an editor of CAP's Black Book , a guide to used car prices explains: 'If the car is worth £2,000 and you owe £3000 you end up giving the dealer money to clear it off.'
However, consumer law allows buyers to hand back a car when they have repaid half the capital without being blacklisted for credit. CAP says dealers are losing out heavily on these deals because customers are doing just that.
Negative equity is also a problem with contract purchase agreements, deals that have been marketed heavily by manufacturers and dealers in recent years. These require deposits of around 20 per cent and lower monthly payments than would be required on a normal finance agreement.
As with hire purchase, you do not own the car, but at the end of a set term you must pay the balance owed, trade it in for a new model or hand it back. But trade-in values have been proving so poor that owners have not been able to trade up to a new car.
Like high street shops, car dealers have been relying increasingly on the selling of finance to supplement their income, according to Goldtharp at CAP. 'In a lot of cases they have pretty much relied on finance and sold cars at a loss.'
Most dealers will have a specialist to sell finance deals to customers and, although commission varies, the dealer might get £100 to £150 for each deal sold.
'They will take as much out of the customer as they can,' says Goldtharp.
In addition to loans for the cars, the sales specialist will probably also try to sell insurance to cover loans against illness or redundancy and this 'gives an extra commission again'.
Problems with negative equity are beginning to subside because car prices have begun to stabilise. Nevertheless CAP recently warned that car owners should still be wary of low-deposit finance deals.
Goldtharp points out that the prices of cars rarely go up, even in a buoyant market, and that conditions can change.
He says: 'Imagine buying something last September that you won't pay off until the next Olympics.'
