If you’ve been following auto news over the past year, it should come as no surprise that the current state of financing paints a concerning picture. According to experts, underwater car loans are climbing, with no signs of going back down any time soon. Edmunds data shows that 24.9% of trade-ins toward new car purchases had negative equity in 2024, up from 20.4% in 2023.
Between the increasing number of underwater trade-ins and the growing severity of US drivers’ negative loan equity, there may be trouble ahead for the auto industry. Fortunately, there are a few measures that dealers and lenders can take as we navigate an uncertain future.
Table of Contents
The Problem of Negative Equity in Auto Loans
Analysts everywhere have been sounding alarm bells over the worsening problem of Americans who are upside down on their car loans. Not only is the share of underwater trade-ins up nearly five percentage points compared to the previous year, but among these unfortunate drivers, the amount they owe is also climbing.
Edmunds reported that the average amount owed on upside-down loans climbed to an all-time high of $6,458 in Q3 2024, compared to $5,808 in Q3 2023. Even more concerning, the customers who are most in debt are falling deeper into the hole.
Over one in five consumers with negative equity owe more than $10,000 on their auto loans, and 7.5% owe more than $15,000. As negative equity persists across all vehicle types being traded in, experts speculate that this is more of a widespread trend than a localized issue.
Breaking down the factors
Some experts say that the issue of underwater loans can be boiled down simply– it’s the natural result of the combination of depreciating assets and extended loan terms. However, extenuating circumstances over the past few years have intensified the impacts.
“Many consumers who purchased new vehicles during the inventory crunch of 2021-2022 paid over MSRP, so they didn’t chip away at the principle of their loans in a traditional manner,” said Jessica Caldwell, Edmunds’ head of insights.
At the same time, the resulting financial hardship is also pushing drivers to sign extended loan terms for their next car.
Caldwell speculated on how consumer behavior is exacerbating the issue. “Car shoppers have been increasingly opting into longer loan terms to reduce monthly payments, and they’re also trading in their vehicles earlier than is financially prudent,” she said.
The impact of these extended loan terms is staggering. A survey by CarEdge, a car marketplace, found that car owners with 84-month loan terms are about $5,000 underwater on average. By contrast, buyers with a 36-month loan have an average of $12,340 in equity.
Putting it into context
Despite the startling statistics, some industry leaders believe that concerns around auto loans are overstated. Motor1 staff writer Victoria Scott reported that although the numbers may look high, they represent a relatively small portion of drivers.
She pointed out that 43% of new car buyers had a trade-in in the first place. Furthermore, although nearly one quarter of these buyers had negative equity, the remainder were break-even, paid off, or had positive equity.
In 2019, for comparison, 34% of buyers with trade-ins were underwater, with an average of $5,251 in negative equity. Additionally, although 22% of underwater buyers have $10,000 left to pay on their trade-in, the average age of these vehicles has also increased to 3.7 years, up from 3.4 in 2023.
Taking these details into account, these observers argue that the situation isn’t as dire as headlines might suggest. However, growing debt levels make it difficult to predict how far the problem will progress.
How Underwater Loans Impact Dealers and Lenders
The increasing prevalence of underwater car loans has a wide range of implications for the auto industry as a whole, but the biggest consideration for dealers and lenders is the increased risk of default in borrowers with negative equity.
For drivers already facing financial difficulties, cutting an upside-down auto loan is a tempting way to decrease costs. That’s why data reflects lenders are adjusting for this risk when approving loans. According to research by Kelley Blue Book, lenders were less likely to accept borrowers with negative equity in December 2024, despite an overall increase in loan approval rates.
But risk prevention doesn’t need to stop in the financing office. Let’s get into how you can protect your business from growing affordability risks.
How to Mitigate Risk as Consumer Debt Rises
When it comes to controlling impact from upside-down loans, you need to start by thinking long term. For instance, talking a buyer into a car they can’t afford may pay off today, but it could also make it harder to build a sustainable revenue engine later on.
Instead of only focusing on new business, it’s important to recognize the impact returning customers have on your bottom line. According to Cox Automotive, every one percent increase in sales retention translates to a $150,000 annual increase in revenue for the average dealer. Not only does looking out for your customers promote trust and loyalty, but it also helps protect their financial situation so they can keep coming back.
1. Take action before loans go upside-down
Even in tough economic conditions, there’s a lot consumers can do to stay on top of their auto loans. As a lender, you can also do your part to take action in critical moments.
One common strategy at the start of the loan is encouraging customers to put down a larger down payment. You can incentivize this by offering shoppers tiered interest rate structures, or just work it into F&I training.
Similarly, some recommend prioritizing shorter loan terms to keep payment plans more in line with consumer habits. As data shows, these financing types ensure that your customer’s vehicle is paid off before it’s time to trade it in. Not only does that keep consumers spending within their means, but it also decreases the chance of default.
Already have some long-term loans in your portfolio? You can still take action before they become problematic. By monitoring your accounts for early warning signs, you can identify at-risk borrowers before they fall seriously behind. For instance, knowing the correlation between insurance policy cancellation and loan defaults, you can leverage your insurance monitoring solution to signal when an account may need intervention.
2. Focus on customer education
Facilitating a transparent financing process can ensure that your customers make the best decision for them. Some lenders achieve this by developing financial models to show shoppers repayment scenarios for different loan terms. By clearly illustrating the long-term cost implications of extended loan terms, this can help customers make more informed decisions.
In providing consumers with robust educational resources, lenders can help customers better understand the relationship between loan terms and vehicle depreciation, leading to more sustainable lending relationships.
3. Make GAP insurance a requirement
When you back an underwater loan, the biggest risk you take on isn’t that it’ll default– it’s that the car will be totaled before it’s paid off. In many cases, the driver won’t have the funds to pay the uncovered balance, and the lender will be left to foot the bill. That’s where Guaranteed Asset Protection, or GAP insurance, comes in.
GAP insurance reduces risk to both the consumer and the lender in case of a total loss by covering the difference between the insurance payout and the remaining loan balance. Given current market conditions, many lenders are making GAP coverage mandatory for high-risk loans, particularly those with minimal down payments or extended terms. Although it slightly increases insurance premiums, it’s well worth the protection it provides.
Some lenders may even implement an insurance tracking system to ensure that the consumer maintains their GAP coverage. With CheckMy Driver’s monitoring feature, you can verify your borrowers’ insurance on an ongoing basis to make sure your assets stay protected.
Looking Ahead
The rising prevalence of underwater car loans poses a risk to consumers and businesses alike. Fortunately, by working collaboratively with their customers, dealers and lenders can help limit the impact of this trend.
Learn more about how CheckMy Driver can help your business in an uncertain lending environment. You can also reach out to our team with any questions or to set up a live walk-through.
