Underwater Auto Loans Reach Four-Year Peak, Impacting New Car Buyers
More American drivers are finding themselves “underwater” or “upside down” on their auto loans, owing more on their vehicles than the cars’ current market value. This rising trend is complicating the process of purchasing new vehicles.
According to Edmunds, an automotive research firm, 26.6% of trade-ins used toward new car purchases in the second quarter of 2025 carried negative equity. This marks a slight increase from 26.1% in the first quarter and represents the highest proportion seen since early 2021, when 31.9% of trade-ins were underwater.
Magnitude of Negative Equity and Loan Trends
The average amount owed on underwater loans during this period was $6,754, a modest decrease from $6,880 in the previous quarter. Ivan Drury, director of insights at Edmunds, described these figures as “staggering,” highlighting the financial strain on consumers.
Drivers often become underwater due to vehicle depreciation and financial choices such as longer loan terms and smaller down payments. Brian Moody, senior staff writer at Autotrader and Kelley Blue Book, notes that vehicles start depreciating immediately, sometimes placing buyers underwater from the outset.
Longer loan durations have become increasingly prevalent, with 84-month auto loans accounting for 21.6% of new auto loans in Q2 2025, up from 19.2% in the prior quarter. Meanwhile, 72-month loans declined to 36.1% from 38.6%. Drury emphasizes that extending loan terms is a common strategy consumers use to reduce monthly payments despite increasing overall debt exposure.
Risks Posed by Negative Equity
While negative equity may not be problematic for those who retain their vehicles, it becomes a significant issue when selling or trading in a car. Additionally, if a vehicle is totaled, insurance typically reimburses only its actual cash value, leaving owners responsible for any remaining loan balance.
Strategies for Buying a New Car When Underwater
Experts recommend keeping current vehicles if possible to avoid rolling negative equity into new loans or paying cash upfront. When purchasing a new vehicle is necessary, consumers should conduct thorough research before visiting dealerships.
Drury advises borrowers with negative equity to seek lower-interest loans to reduce borrowing costs. Understanding one’s credit score is essential since it influences loan terms and interest rates, Moody adds.
Obtaining pre-approval from multiple lenders can help secure the best financing offers, and dealers may match or improve these rates. For buyers likely to remain underwater on new loans, gap insurance is recommended. This coverage protects against the shortfall between a vehicle’s worth and the loan balance in the event of a total loss.
The Insurance Information Institute notes that gap insurance typically adds about $20 annually to comprehensive and collision premiums.
FinOracleAI — Market View
The rise in underwater auto loans signals increased financial vulnerability among consumers, potentially dampening new car sales in the short term as buyers hesitate due to negative equity burdens. The trend toward longer loan terms may temporarily sustain demand but raises credit risk for lenders. Market participants should monitor shifts in loan durations, interest rates, and credit availability, as well as the adoption of gap insurance products. An economic downturn or rising interest rates could exacerbate defaults, impacting auto financing sectors.
Impact: negative
