What Is Negative Equity on a Car?

Vehicle ownership often involves financing, where a borrower takes out a loan to cover the purchase price of a car. This financial arrangement typically requires regular payments over a set period, gradually reducing the amount owed. Understanding the dynamics of car loans and vehicle value is important for anyone considering or currently managing vehicle financing.

Understanding Negative Equity

Negative equity on a car occurs when the outstanding balance of a car loan exceeds the vehicle’s current market value. This situation means that if the car were to be sold, the sale proceeds would not be enough to fully pay off the loan. It is sometimes referred to as being “upside down” or “underwater” on a loan.

This imbalance between the loan amount and the car’s worth can create difficulties for owners who wish to sell or trade in their vehicle. The difference represents a financial deficit that must be covered by the owner.

How Negative Equity Happens

A primary driver of negative equity is the rapid depreciation of a vehicle’s value, particularly during the initial years of ownership. New cars can lose a significant portion of their value, sometimes as much as 20% or more, within the first year of ownership alone, and continue to depreciate by an additional 15% to 25% annually for the next few years. This swift decline often outpaces the rate at which the loan principal is paid down, especially in the early stages of a loan where interest payments are higher.

Longer loan terms, such as 72 or 84 months, also contribute to negative equity by stretching out the repayment period and slowing down equity accumulation. With extended terms, the principal balance decreases more slowly, making it harder for the loan balance to catch up with the car’s depreciating value. Low or no down payments exacerbate this issue, as the loan starts at or very near the full purchase price of the vehicle, leaving little initial buffer against depreciation. For instance, a common recommendation is a down payment of at least 10% for a used car and 20% for a new car.

High interest rates further compound the problem by increasing the total amount of interest paid over the life of the loan, which can keep the outstanding principal higher for longer. The average car loan interest rate for new cars was 6.73% and for used cars was 11.87% as of March 2025. Rolling over negative equity from a previous car loan into a new one immediately puts the new loan underwater. This practice adds the deficit from the old car onto the new car’s loan, beginning the new financing arrangement with a higher principal than the new vehicle is worth.

Calculating Negative Equity

Calculating negative equity involves a simple calculation. You need to know your current outstanding car loan balance and the car’s current market value. The formula is straightforward: Loan Balance – Car’s Current Market Value = Negative Equity.

To find your car’s current market value, you can use reputable online valuation tools. Websites like Kelley Blue Book (KBB.com) or Edmunds (Edmunds.com) allow you to input your car’s specific details, such as make, model, year, mileage, and condition, to generate an estimated market value. For example, if your loan balance is $18,000 and your car’s market value is $15,000, you have $3,000 in negative equity ($18,000 – $15,000 = $3,000).

Options for Addressing Negative Equity

To address negative equity, make additional payments towards your loan principal. Paying more than the minimum required amount each month accelerates the reduction of your loan balance, helping to close the gap between what you owe and what the car is worth. Even small additional payments can make a difference over time by reducing the total interest paid and shortening the loan term.

Another approach is to simply keep the vehicle for a longer period. As you continue to make payments, the loan balance will decrease, while the rate of depreciation typically slows down after the first few years. Over time, this allows the loan balance to potentially fall below the car’s market value, bringing you out of negative equity.

Trading in a vehicle with negative equity means the outstanding balance is added to the new car loan. For instance, if you have $3,000 in negative equity and trade in your car for a new one costing $25,000, your new loan amount would effectively start at $28,000 plus any new taxes and fees. This practice can lead to a larger new loan and potentially higher monthly payments.

Selling the car privately might be an option, but you would be responsible for covering the difference between the sale price and the loan payoff amount. If you sell the car for $15,000 and still owe $18,000, you would need to pay the lender the remaining $3,000 out of pocket to clear the loan. Refinancing the loan could be considered if interest rates have dropped or your credit score has significantly improved, potentially lowering your monthly payments and allowing you to pay down the principal faster. However, lenders may be hesitant to refinance a loan that is significantly underwater due to increased risk.

Preventing Negative Equity

To proactively avoid negative equity, making a substantial down payment when purchasing a vehicle is highly beneficial. A down payment of at least 10% for used cars and 20% for new cars is often recommended because it immediately creates equity and reduces the initial loan amount. This buffer helps to counteract the rapid depreciation that occurs early in a car’s life. A larger down payment also reduces the total amount of interest paid over the life of the loan.

Choosing a shorter loan term, such as 36 or 48 months, can also help prevent negative equity. While shorter terms typically result in higher monthly payments, they ensure that the loan principal is paid down more quickly, aligning better with the car’s depreciation curve.

Carefully selecting a vehicle model known for better depreciation rates can also be a wise decision. Some cars retain their value better than others, making them less susceptible to falling into negative equity. Researching resale values before purchase can provide insight into a vehicle’s long-term financial performance. Lastly, it is important to avoid rolling over negative equity from a previous loan into a new one, as this immediately puts the new financing in a disadvantageous position.