How an 'Underwater' Car Loan Can Wipe Out Your Life Savings — and How To Protect Yourself
An “underwater” car loan can become a serious problem for many drivers, putting savings and long-term financial goals at risk.
Understanding how negative equity works can help protect you from costly mistakes. Find out more below.
What Is Negative Equity?
According to Edmunds, when you owe more on a car than it is really worth, it can leave your loan in an “underwater” or “upside-down” situation. According to an Edmunds report, in the second quarter of 2025, 26.6% of new vehicle trade-ins were considered to be “underwater.”
At the beginning of a car loan, the payments are structured to go toward interest first and then eventually toward the bulk of the loan. To avoid putting yourself in an “upside-down” situation, the down payment must be large enough to offset depreciation. A new car will experience a certain amount of depreciation during the first few years after purchase. But it takes years of paying on the loan to reduce it to an amount equal to the car’s value.
There are many reasons why someone could end up with negative equity on their car loan. If the negative equity is large enough to carry over to the next loan, then the debt will be bigger, which can result in higher monthly payments. Continuing to carry this debt will eventually limit your financial flexibility. Trying to pay it off could require dipping into savings or other funds, like an emergency fund. The Edmunds report also showed that “32.6% of trade-ins had between $5,000 and $10,000 in negative equity.”
Options To Deal With Negative Equity
One option is to keep your current car and reduce your loan balance faster by making extra payments.
Another option is to find the difference between your loan balance and your vehicle's value. If you can pay that amount out of pocket, then you can avoid carrying the debt into your next loan or lease.
A third option is to check on refinancing your loan. Ask if it is possible to refinance the loan with a shorter term or lower interest rate.
If you were planning on trading in your vehicle, consider selling it privately instead. It is possible to sell your car for more than a trade-in would bring. Then use the money towards the loan or lease. You may still have some negative equity, but it will definitely be less than before.
Also, consider leasing. Leasing a new car would carry the balance you owe over into the lease, but with higher monthly payments. Since most leases are three years, this would allow you to pay off the negative equity over that period. Ask whether you qualify for lease specials with a lower monthly payment.
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.