More and more consumers are finding themselves trading in vehicles that they owe more on than the vehicles are actually worth, with the amount of money still owed on their auto loans reaching unprecedented levels.
Consider upgrading to a new car or truck when you already owe about $7,000 more than the value of your current vehicle. The situation becomes even more challenging if the vehicle in question is an electric one.
This upside-down scenario leaves consumers with limited funds for a down payment, increasing their risk of accumulating excessive debt with their next vehicle purchase.
Underwater Car Loans Are More Common Than You Think
Research from Edmunds indicates that during the last quarter of the previous year, one in four vehicles traded in for a new purchase had negative equity, often referred to as being “underwater” or “upside down.”
Last year, 24.9% of these trade-ins had negative equity, a noticeable increase from 20.4% in the last quarter of 2023. However, these figures are not unprecedented. In late 2019, the percentage of trade-ins with negative equity reached 32.7%.
Record High Amounts Owed on Underwater Auto Loans
The startling revelation is the soaring amount of money owed by consumers on these underwater loans.
On average, the amount owed was $6,838, which is the highest it has ever been. Even more concerning, about one in four consumers with negative equity owe upwards of $10,000 on their loans when they go to trade in their vehicle. Additionally, 8.5% owe $15,000 or more.
Many of these vehicles being traded in are relatively new, with the average age being just 3.3 years. Over the past five years, vehicles traded in under these circumstances were typically around the three-year mark.
What’s Causing These Financial Strains?
Ivan Drury, director of insights at Edmunds, explains that many borrowers may not be aware that the interest on car loans is predominantly paid at the beginning of the loan term. The largest portions of early payments are applied to interest, not principal, which means less equity is being built in the vehicle.
“Unless you’re dealing with a 0% interest rate, most of your initial payments are going toward interest,” Drury stated.
For a couple of years, particularly in 2021 and 2022, a shortage of used cars caused their values to spike, protecting many consumers from negative equity. “You could sell your car back to the dealership for nearly the same price you paid just a year prior,” Drury recalled.
However, the subsequent normalization of the market, coupled with an influx of new cars and a decline in used car prices, has changed the dynamics significantly.
Drury noted that many consumers had to take out larger loans due to the inflated prices of vehicles during this period. Additionally, the depreciation of used car values and longer loan terms have left many in precarious financial positions.
“You’re not giving yourself any financial leeway,” he commented.
Changes in life circumstances, such as marriage or expanding families, can also prompt consumers to trade vehicles sooner than anticipated, often exacerbating negative equity issues.
Increased Risk for Electric Vehicles
To find out if you’re underwater on your loan, compare the current value of your car against the payoff amount listed on your latest auto loan statement. Various online platforms, including Edmunds, can provide you with this data.
For instance, owners of a 2021 Toyota Camry found themselves, on average, $7,236 underwater in the last quarter of 2024. Meanwhile, those who financed a 2022 Land Rover Range Rover were looking at an average negative equity of approximately $10,900.
Electric vehicle owners tend to face higher risks of negative equity. The average amount owed on all EVs with negative equity traded in during the last quarter of 2024 was $10,186, an increase from $7,116 in the fourth quarter of 2022.
“Electric vehicles depreciate faster and generally have poorer residual values,” Drury explained, advising caution to recent EV purchasers.
How to Gauge Your Vehicle’s Worth
You can monitor the value of your vehicle over time by using tools like the “Trade in history” feature available on Edmunds.com/appraisal/history.
Drury suggests leasing as a potentially smarter option for those who like to switch cars frequently, as it might prevent recurring negative equity from compounding with each new vehicle purchase.
However, when trading in a car with negative equity, consumers often find themselves facing higher borrowing costs and monthly payments. Some might even need to contribute additional cash for a down payment.
On average, buyers trading in vehicles with negative equity in the last quarter of last year faced an additional $159 in monthly payments and financed $12,388 more than the industry average for all new vehicles. Both figures represent all-time highs.
Drury warns of the severe consequences of trading in a vehicle with substantial negative equity, which can lead to a cycle of poor financial decisions in auto financing.
Those significantly underwater might find it wiser to retain their vehicle longer while maintaining regular payments and upkeep.
You definitely want to avoid being so underwater on a car loan that it drowns you in debt.
Contact personal finance columnist Susan Tompor: stompor@freepress.com. Follow her on X @tompor.
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Passionate about analyzing economic markets, Alice M. Carter joined THE NORTHERN FORUM with a mission: to make financial concepts accessible to everyone. With over 10 years of experience in economic journalism, she specializes in global economic trends and US financial policies. She firmly believes that a better understanding of the economy is the key to a more informed future.