Negative equity occurs when you owe more on your auto financing than the car is currently worth. It’s sometimes called being “upside down” or “underwater,” and it’s more common than many buyers realize.

Negative equity: What it is

Several factors can lead to negative equity. First, new cars depreciate rapidly by losing up to 20% of their value in the first year alone. If you made little or no down payment when financing, the balance you owe may not shrink as fast as the vehicle’s value. Things that contribute to negative equity include longer-than-normal financing periods, low initial payments, or rolling in prior debt.

For example, if you buy a $20,000 car with no down payment and stretch payments over 72 months, your balance may still be close to the full purchase price a year later — even though your car might now be worth only $16,000.

How negative equity affects car financing

Being upside down affects your financial options and flexibility. Suppose you trade in your car before reaching positive equity. In that case, the unpaid balance is rolled into your new auto financing, making your next car more expensive and continuing the negative equity cycle.

How to protect yourself from being upside down

There are a few ways to minimize your risk. One is making a down payment of at least 20% to offset the effects of initial depreciation. You can also choose a shorter finance term, ranging from 36 to 60 months. Doing so accelerates principal repayment and helps you build equity faster. You can additionally opt for a certified pre-owned or used car, since these vehicles depreciate more slowly after their initial drop in value.

During ownership, regularly visit resources such as Kelley Blue Book or Edmunds to track your car's value. When your budget allows, making extra “principal-only” payments is a good way to stay ahead of depreciation and avoid being upside down.

You may want to investigate gap insurance as well. If your car is totaled or stolen, a standard insurance policy only pays market value — not what you owe — leaving you responsible for the difference. This is a good hedge for those who’ve only made a small down payment or took on long finance terms.

Should you find yourself already saddled with negative equity, don’t despair! We have some advice on how to deal with it.

Need help with financing options?

If you’re looking to finance a vehicle, (even if you have negative equity in your vehicle) start by getting pre-qualified through Credit Acceptance’s website. We’ll then share a shortlist of dealers in your area, from our network of over 15,000 dealerships who may be able to help.