What Does Being Upside Down on a Car Loan Mean?

Being “upside down” on a car loan, also known as negative equity, means the outstanding balance of your auto loan is greater than the vehicle’s current market value. For example, if you owe $20,000 on your car but its market value is only $18,000, you have $2,000 in negative equity. This situation creates challenges when considering future vehicle transactions.

Why a Car Loan Becomes Upside Down

A reason for negative equity is the rapid depreciation of new vehicles. A new car can lose approximately 10% of its value within the first month of ownership and around 20% by the end of the first year. This quick decline means the car’s market worth often falls faster than the loan principal is paid down, especially in the initial stages. Over five years, a new car can lose about 60% of its original value.

Long loan terms also contribute to negative equity. While extended terms, such as 60, 72, or even 84 months, can lower monthly payments, they slow the rate at which the principal balance is reduced. This prolonged repayment period means the car’s value may remain below the outstanding loan balance for a longer time. The average new car loan term in early 2025 was around 68.6 months, or nearly six years.

An insufficient down payment increases the risk of negative equity. When a small or no down payment is made, a larger portion of the car’s purchase price is financed, increasing the initial loan amount. A substantial down payment, often recommended at 10% to 20% of the car’s price, helps create immediate equity, acting as a buffer against depreciation. Without this buffer, the car’s value can quickly dip below the loan amount.

Rolling over negative equity from a previous vehicle into a new car loan can worsen the problem. This practice adds the unpaid balance from an old loan to the new loan, immediately increasing the financed amount for the new vehicle. This can result in owing more on the new car than it is worth from the beginning.

Navigating an Upside Down Loan

Being upside down on a car loan presents challenges when transacting with the vehicle. When trading in a car with negative equity, the dealership typically incorporates the outstanding balance into the new car loan. This means the negative equity from the old vehicle is added to the purchase price of the new one, increasing the total amount financed and potentially leading to higher monthly payments. Alternatively, the borrower can pay the difference between the trade-in value and the loan balance out of pocket.

Selling a car privately when it has negative equity requires the seller to cover the difference between the sale price and the loan payoff amount. The lienholder will not release the title until the entire loan balance is satisfied. This often means the seller must pay a lump sum to the lender to clear the debt before transferring ownership to the buyer.

In the event of a total loss due to an accident or theft, being upside down impacts the insurance payout. Standard auto insurance policies pay out the actual cash value of the vehicle at the time of the loss, which accounts for depreciation. If this value is less than the loan balance, the car owner remains responsible for the difference. Guaranteed Asset Protection (GAP) insurance can cover this “gap” between the insurance payout and the outstanding loan balance, preventing the borrower from owing money on a car they no longer possess.

Strategies for Managing Negative Equity

One strategy to address negative equity is to make larger or extra payments on the car loan. Applying additional funds directly to the principal balance helps reduce the loan amount faster than scheduled. This accelerated payment reduces the overall interest paid and helps build equity more quickly, bringing the loan balance closer to or below the car’s market value.

Refinancing the loan can also be an option, particularly if market interest rates have decreased or your credit score has improved. Refinancing to a lower interest rate or a shorter loan term can help pay down the principal more efficiently, reducing the time spent in a negative equity position. However, a shorter term will likely result in higher monthly payments.

If immediate sale or trade-in is not necessary, waiting to transact until the loan balance falls below the car’s value is wise. Continuing to make regular payments allows time for the vehicle’s market value and the outstanding loan balance to align. This approach avoids the financial burden of paying out-of-pocket or rolling negative equity into a new loan.

Making a larger down payment when purchasing a vehicle can reduce the likelihood of going upside down. A substantial down payment lowers the initial amount financed, creating immediate equity and providing a cushion against the car’s rapid depreciation. Experts often suggest a down payment of at least 10% to 20% for new vehicles.

Considering cars with slower depreciation rates can also help mitigate negative equity. Some vehicle types, such as trucks and hybrids, tend to retain their value better than others, including certain luxury cars or electric vehicles. Researching depreciation trends for specific makes and models before purchasing can contribute to a more favorable equity position over time.