Negative Equity Car Loans

What is a Negative Equity Car Loan?

Negative equity on a car occurs when the outstanding loan balance on the car is higher than the car is worth.  Negative equity is also know as being “upside down” on a car loan or “underwater”. The number of vehicle owners with negative equity car loans is at an all time high.  In fact, Edmunds recently published a report that showed 44% of new car buyers in April 2020 traded in a car with negative equity.  The average amount of negative equity was $5,571 — an all time high!  Having an upside down car loan is not the end of the world. There are some steps you can take to get back on the right side of your car loan.  Knowing where you stand on your car loan is important and can help you make decisions about the car you currently own and the next one you buy.

How to Calculate Your Car’s Equity

Calculating the equity on your car loan is relatively simple.  Your car’s equity equals your car’s value minus the amount you owe.

  • Ultimately, your car is worth what someone is willing to pay for it.  In order to estimate your vehicle’s value, you can visit multiple free websites like NADA Guides, KBB or Edmunds to get an appraisal of your car.  We recommend you use more than one source so you can see if there is any variability.  Another good tip is to look at private party or for sale by owner listings of vehicles similar to yours.
  • Determining the amount of your vehicle loan should be fairly straightforward.  You can log on to your account and find out what the current balance is.  You may need to look specifically for the payoff amount which will include any interest owed on the balance since the date of your last payment.  If you can’t find it easily online, you can visit or call your bank or credit union and have them tell you directly.

How Negative Equity on Car Loans Can Happen

There are a few key reasons why some cars end up with negative equity.  Understanding how negative equity actually happens is an important part of the car buying process.

  • Decline in Car Value – Negative equity occurs when the rate of your car’s value drops faster than your ability to pay down the loan.  We all know that cars typically go down in value, not up.  New cars can lose as much as 20% of their value in the first year of ownership. There are a lot of things that can impact the value of your car including mileage, general wear and tear and damage.
  • Small Down Payment – A small down payment at the time the car was purchased means more of the price of the car will have to be borrowed.  The higher the amount we have to borrow means the longer it will take to pay the car off.
  • High Interest Rate –  All things being equal, the higher the interest rate on your car loan means more of your monthly payment goes towards interest expense and not towards paying off your car.  Monthly car payments are made up of two things:  interest expense and loan repayment.  Only a portion of your monthly car payment goes toward reducing your auto loan.  The higher your interest rate, the lower the amount that reduces your car loan debt.
  • Long Term Auto Loans — The longer the term of your auto loan, the longer it takes for you to pay off your car loan balance.  Time is not your friend when it comes to negative equity car loans.  Long car loan terms mean more time for your car’s value to depreciate.  A recent auto industry report by Experian showed that the average term on vehicle purchases was 69 months or almost 7 years.

What to Do About a Negative Equity Car Loan

Negative equity in a car is not irrevocable.  If your outstanding loan is more than your car’s value, you can always just wait it out. Stick with your current car and continue making payments until you pay off the loan.  At some point in the following months or years, your balance will be less than your car’s value and you will have positive equity in your vehicle.  If you would rather do something, here are two options that you can take:

  •  Make extra payments on your loan.  Any extra amounts that you pay over your contracted car payment will go towards reducing your car’s debt balance.
  • Refinance your current car loan with your bank or credit union.  It always makes since to see if you qualify for a lower interest rate in a new loan.  You might find that with a lower rate, more of your monthly car payment will go towards reducing your outstanding auto loan balance.  Be sure that the fees associated with your new loan don’t outweigh the benefits.  Also reduce the temptation to enter into a long term loan which can put you in the same situation.  Learn how to use an auto refinance calculator to estimate savings.

The Federal Trade Commission also offers some tips for dealing with negative automobile equity. You may find that you can turn your negative equity around with some solid planning.

Trading in a Car That’s Upside Down

It is possible to trade in a car with negative equity when purchasing a new one.  This is commonly calling “rolling” your debt into your new car loan.    Auto dealerships will simply add your negative equity – the amount of your loan that exceeds your car’s value – on to the amount of your loan for your new car.  They need to pay off the old loan so that the title can be released on it so they can sell it to someone else. This is very common.  Many people trade cars in with negative equity.

Trading a car with negative equity should not be seen as a quick fix.  The amount of negative equity that you have to add on to your loan will cause your car payment to be higher on your new car.  Earlier in this article we shared the the average amount of negative equity on a car that is traded in is $5,571.  This means that on a 5 year loan at 4%, this would add $102.60 to your car payment.  Dealer’s will likely try to get you into a new car with lots of rebates and incentives.  These reductions in price can be applied to your negative loan balance.  Auto Dealerships will take them.  If you are trading in a car with negative equity, try to get as high a value as you can for your car so you can apply a maximum amount to your loan balance.

Tips to Avoid Negative Equity Car Loans

The best time to protect yourself from negative equity car loans is when you purchase your vehicle.  Our top four tips for avoiding upside car loans are listed below. tips from the consumer protection link

  1. Make a big down payment – the larger the amount of your down payment, the less you have to borrow.  Borrowing less means any decline in your car’s value has a lower risk of putting you into a negative equity car loan. The lower your starting loan balance is, the less you have to pay back over time.  Sounds simple but it has a big impact on your equity position in your car.
  2. Get the lowest interest rate you can – The lower the interest rate on your car loan, the bigger the portion of your monthly car payment that goes towards reducing your loan balance.  High interest rates are your worst enemy.  Not only do they make borrowing very expensive but they eat up most of your monthly payments on your car loan so you stay in debt longer.  Curious to see what kind of impact the interest rate has on your monthly payment? Use our auto loan calculator to see the difference in monthly payment resulting from even small increases in interest rates.
  3. Buy a used car –  While new cars are exciting they also can have a sharp drop in value in the first year.  This drop in value, depending on your particular situation, can increase the change that you will be have a negative equity car loan later on.  Buying a used car – one that already has declined in value – might be a good option for you.  This can make you less vulnerable to getting upside down in your loan.
  4. Choose short loan terms – Shorter term loans mean you pay off your loan more quickly.  The faster you pay down your auto loan the less risk you have that the value of your car will be less than your outstanding balance.  When it comes to your equity in your car, you are in a race to reduce your auto loan balance before the value of your car falls below the amount you owe.

Learn more about how to get out of an upside car loan.