A recent report reveals that over 25% of new-car purchasers in the United States owe more on their current car loans than their vehicles are worth. While this might be concerning for financially savvy consumers, it’s only part of the picture. Among those who are in negative equity, over a quarter carried over $10,000 or more in previous debt into their new loans—a record high—resulting in an average negative equity rollover exceeding $7,000 for the first time, states Automotive News. Moreover, it appears this trend will persist in the near future.
The trend of negative-equity trade-ins has been gradually increasing since 2005, with only two notable exceptions, according to information provided to Automotive News by Edmunds. The first was the beginning of the Great Recession; the second was the emergence of COVID. What do these two events have in common? A significant decline in new-car sales.
Following both occurrences, new-car sales dropped sharply. In the former, the economic downturn was the main factor—buyers simply couldn’t afford new vehicles in a contracting economy with stricter lending criteria. In the latter, the problem was more about the shortage of new cars, as dealerships closed during the early days of COVID.
The frequency and scale of underwater trades can be illustrated in the chart above, initially created by Automotive News using data from Edmunds. The empty space corresponds with yet another factor, which the author adjusted the graphic to incorporate: used car values.
While consumers are bearing higher balances on their underwater loans than after the Great Recession, the number of underwater loans has only returned to the levels observed in 2014-2015. Rates peaked in 2019-2020—just before the COVID downturn—but the average outstanding amount has been in unprecedented territory since late 2023 or early 2024.
In both scenarios, we can observe the connection between the number of underwater new-car loans, the magnitude of negative equity held, and the resulting effect on used-car prices. With affordable, available financing, buyers tend to trade in their underwater loans more often (and with greater debt). When the economy shifts or availability tightens, preference moves to used cars, which then witness their own price increase. This phenomenon occurred post-COVID; it was the mechanism that nearly led to Carvana’s bankruptcy—the first time, at least.
The preceding information is from the CarGurus used-car price index tracking back to January 2021. Notably, this curve aligns closely with the latter part of the graphic from Automotive News. Indeed, used car prices have been decreasing, although not to the levels witnessed in the years leading up to COVID, when used-car values remained relatively stable.
There is some positive news on this front, especially for those interested in alternative powertrains. While the recent end of the CarGurus index suggests a minor increase in used-car prices, a wave of used EVs and plug-in hybrids is set to enter the market as their leases come to an end. Provided the broader economy holds steady, we might see some relief in this area, despite inflation remaining at its current level.
Got a news tip? Share it with us at [email protected]!
**US Car Buyers Encounter Record High Negative Equity on Existing Loans**
In recent times, the automotive sector in the United States has undergone notable shifts, resulting in a troubling trend for vehicle purchasers: unprecedented negative equity on outstanding loans. Negative equity arises when the remaining balance on an auto loan surpasses the current market value of the car. This condition presents financial hurdles for consumers seeking to trade in or sell their automobiles.
**Comprehending Negative Equity**
Negative equity is especially common in the auto industry due to the swift depreciation of vehicles. New cars can depreciate by as much as 20% within the first year of ownership. Consequently, numerous buyers find themselves owing more on their loans than their cars are worth, particularly if they financed their purchases with minimal or no down payment.
**Current Dynamics in the Automotive Market**
Various factors have led to the increase in negative equity among US car buyers:
1. **Escalating Vehicle Prices**: The automotive sector has witnessed a rise in vehicle costs, fueled by supply chain disruptions, semiconductor shortages, and heightened demand. As prices increase, buyers frequently take on larger loans, which can result in negative equity if the vehicle’s value depreciates swiftly.
2. **Elevated Interest Rates**: As the Federal Reserve raises interest rates to address inflation, auto loan interest rates have also surged. Increased rates translate to higher monthly payments and an increased likelihood of buyers borrowing more than the vehicle’s worth.
3. **Extended Loan Terms**: Many consumers are choosing longer loan periods to make monthly expenses easier. While this can reduce the short-term financial burden, it may also result in a scenario where buyers continue to pay for their loans long after the vehicle has lost value.
4. **Trade-In Difficulties**: As negative equity becomes prevalent, trade-in values can decline. Dealerships may offer lower trade-in values to counterbalance the negative equity, forcing consumers to choose between rolling over the debt into a new loan or covering the difference out of pocket.
**The Effects on Consumers**
The repercussions of high negative equity are considerable for car buyers. Individuals in this situation may find it difficult to upgrade to a new vehicle or could face financial challenges if they need to sell their car unexpectedly. Furthermore, negative equity can restrict refinancing options or obtaining favorable loan terms, complicating the financial landscape for consumers.
**Navigating Negative Equity**
For car buyers grappling with negative equity, several tactics can help alleviate the situation:
1. **Enhance Down Payments**: Making a larger down payment can lessen the loan amount and help prevent negative equity from the beginning.
2. **Opt for Shorter Loan Terms**: Choosing a shorter loan duration may result in higher monthly payments but will facilitate quicker equity building.
3. **Consider Pre-Owned Vehicles**: Buying a used vehicle can often deliver better value and slower depreciation, thus decreasing the likelihood of negative equity.
4. **Monitor Vehicle Value**: Keeping an eye on the vehicle’s market value can assist buyers in making informed choices about when to sell or trade in their cars.
5. **Seek Financial Guidance**: Getting assistance from financial experts can offer customized strategies for managing current loans and navigating the intricacies of negative equity.
**Conclusion**
As US car buyers deal with unprecedented negative equity on outstanding loans, grasping the factors contributing to this trend and exploring possible solutions is vital. By making well-informed decisions and embracing proactive financial approaches, consumers can better handle the challenges of the automotive market and strive towards a more secure financial future.