Auto Buying: How To Deal With Negative Equity

Read Time: 4 minutes

Lower auto prices should be a good thing for consumers, but that may not be the case for those with a vehicle to trade in. The problem is that many owners are financially upside down, a situation where a car’s loan balance is greater than the vehicle’s current market value.

Underwater auto financing is a byproduct of the overall decline in auto pricing. Cox Automotive reports that vehicle prices fell 3.5% between January 2023 and January 2024. Lower prices make new cars more attractive, but they also force down used-car values.

The result, according to the Edmunds Used Vehicle Report, is that “the average transaction price (ATP) for all used vehicles in Q4 2023 dipped to $28,371, a 4.4% decrease from $29,690 in Q4 2022.”

While car values move up and down, the same is not true for automotive financing. If you borrow $25,000 in auto financing, that’s what the lender expects to be repaid, plus interest.

With each monthly payment, the amount owed to the auto lender falls. However, if the vehicle is fairly new, a situation can arise where the fair market value of the car is less than the remaining loan balance.

This is called “negative amortization” and it’s becoming more common. Edmunds says 20.4% of new vehicle sales with a trade-in had negative equity in the fourth quarter of 2023 versus 14.9% two years earlier.

When car financing is upside down, there are several important considerations.

First, selling the car will not put cash into your bank account.

Second, if the car is sold, you’ll need cash to pay off the loan balance. In other words, if the trade-in vehicle is worth $22,000 and the outstanding loan balance is $23,000, the owner will need $1,000 in cash to settle the debt.

“While people who bought a car years ago might not see why the new car market could affect the value of the vehicle in their driveway, trade-ins with negative equity have become increasingly prevalent as used vehicle values dwindle,” said Edmunds. “The vehicles most affected by negative equity tend to be newer trade-ins that were once highly sought after but now face steeper depreciation.”

Third, some auto loans include a prepayment penalty for an early pay-off. Always be sure you understand the full and final cost to pay off your financing.

Rolling Over An Existing Auto Loan

You might be able to buy a vehicle with no money down even if you have negative equity, but that can be an expensive choice.

“It’s possible to buy a car without a down payment,” says Experian, one of the three major credit reporting agencies (CRAs) in the US, “but it may not always be a good idea. Buying a car with no down payment generally means higher car payments and auto loan interest rates, costing you more in the long run.”

“Dealers,” according to the Consumer Financial Protection Bureau (CFPB), “occasionally have vehicle trade-in offers, and if the dealer promises to pay off your negative equity, make sure it’s not included in your new financing or your final loan contract. Before finalizing a loan, read the contract carefully, and don’t sign anything until you understand and are comfortable with the terms.” 

The Two-car Dilemma

In a situation with negative equity, some car buyers might think about purchasing a new car and keeping the current vehicle. The catch is that such an arrangement may not be possible if the buyer is still making payments on the old car.

Lenders will check the buyer’s debt-to-income (DTI) ratio when considering an auto loan. Add required monthly payments for two cars — plus costs for such expenses as student debt, credit cards, and housing — and borrowers may have “too much” monthly debt. When this happens, lenders see more risk and that means a higher interest rate or maybe even a loan rejection.

A Negative Equity Solution: The Short-Term Delay

Negative equity means that some auto buyers will have to change plans. For many buyers, the best option can be to postpone a new car purchase to the end of the month or the end of the year.

These are times when dealers want to report strong sales and are more likely to make concessions. Or, buyers may want to wait for the Fall new car introductions when dealers want to move “older” inventory off their lots.

The advantage of delay is that with each monthly payment the amount owed to the auto lender for the current vehicle goes down. This can mean the present car is no longer underwater when it’s time to buy a replacement vehicle.

With more time, owners can also set aside money to build a solid down payment. If a typical new-car payment is $700, borrowers can save that amount each month until they have enough for a 10% down payment.

If a new car costs $40,000 it will take just six months to accumulate the needed money. With a strong down payment borrowers may be able to get a lower interest rate and smaller monthly payments.

Peter G. Miller

Peter G. Miller is a nationally-syndicated columnist, the author of seven books published originally by Harper & Row (including one with a co-author), and has contributed to leading online sites and major print publications. He has appeared on numerous media outlets including the Today Show, Oprah!, CNN, and NPR.

Peter has been an accredited correspondent on Capitol Hill and a member of the White House Correspondents Association. He has served with the District of Columbia National Guard and holds both BA and MS degrees from The American University in Washington, DC. View Peter on LinkedIn.

Compare Rates and Save on Your Auto Loan

See Today's Rates