A growing number of Americans are finding themselves in negative equity on their car loans, with the average outstanding amount reaching a record level, according to a recent survey by the car comparison platform Edmunds.

In the quarter ending September, 24.2% of Americans who traded in their vehicle for a new purchase had debts exceeding the car’s value, a situation known as being “upside down” or “underwater.” This figure has risen from 23.9% in the previous quarter and from 18.5% a year ago. Furthermore, the debts associated with these trade-ins have soared to an all-time average of $6,458, with 22% of individuals owing at least $10,000 and 7.5% owing $15,000 or more, as stated by Edmunds.

Auto loans represent approximately 25% of consumer credit excluding mortgage debt, as per the Federal Reserve. They can reflect the financial health of borrowers as well as the overall economic conditions for households.

“While owing a little more than a thousand dollars on a car isn’t catastrophic, the high percentage of people with debts around $10,000 or even $15,000 is genuinely concerning,” commented Jessica Caldwell, head of insights at Edmunds.

What Causes Many Americans to be Underwater on Car Loans?

Several factors are driving this issue, according to experts at Edmunds.

Firstly, Americans who purchased new vehicles during the supply shortage of 2021-2022, shortly after the pandemic, paid top dollar. According to Caldwell, they “overpaid relative to MSRP (manufacturer’s suggested retail price), which limited their ability to reduce the principal on their loans normally.”

Moreover, as car manufacturers rebuilt their inventories and the economy slowed down, they reintroduced incentives that had decreased the trade-in values for nearly new vehicles, Caldwell explained.

Lastly, car buyers are coping with higher prices by “opting for longer loan terms to lower their monthly payments,” Caldwell noted.

These extended terms, combined with the trend of trading in vehicles prematurely, increase the risk of car owners transferring negative equity into their subsequent loans, she added.

Edmunds found that even those taking longer loan terms are facing monthly payments of $1,000 or more at near-record rates. This group accounted for 17.4% of new car buyers from June to September.

A study from the Federal Reserve last month indicated that higher monthly car payments are often associated with increased delinquency rates.

Who is Most Likely to Be Underwater?

Anyone can find themselves in this situation. Negative equity is common across all vehicle categories, according to Edmunds.

For instance, midsize SUVs, compact SUVs, and large trucks represent 19.5%, 17.3%, and 10.3% of all vehicles surrendered with negative equity, respectively.

“Many might think that only certain consumers trading in more expensive luxury cars face negative equity, but this problem spans a wide range of vehicle types,” said Ivan Drury, director of insights at Edmunds.

How Can Americans Steer Clear of Being Underwater on Car Loans?

To mitigate the risk, Americans should prioritize regular maintenance and keep their vehicles for as long as feasible to lessen further depreciation, says Edmunds.

If purchasing a vehicle is necessary, Drury suggests:

• Look for incentives and lower APR financing options, which are currently rare.
• Consider selecting vehicles known to retain their value better or those that provide financial advantages such as improved fuel efficiency or lower insurance rates.
• Choose a car that you genuinely desire and enjoy, as failing to do so may lead to prematurely trading in a relatively new vehicle,” he advised.