Negative equity, also known as being “upside-down” on a car loan, happens when you owe more on your car loan than the vehicle is worth. It’s a common issue for car buyers, but with the right strategies, you can avoid falling into this financial pitfall. Here’s how to steer clear of negative equity and make smarter car-buying decisions.

What Is Negative Equity?

Negative equity occurs when the market value of your car is less than the remaining balance on your loan. For example, if your car is worth $20,000 but you still owe $25,000, you’re upside-down by $5,000. This situation can limit your options if you need to sell or trade in the car, as you’ll have to cover the difference out of pocket. Getting rid of a car with negative equity is a stressful task, with only a few options.

That’s why it’s so important to avoid negative equity in the first place. Below are 10 things you can do to prevent negative equity car loans. 

How to Avoid Negative Equity on a Car Loan

1. Choose a Shorter Loan Term

Long-term car loans (longer than 60 months) may lower your monthly payments, but they greatly increase the risk of negative equity. Our most recent Negative Equity Report found that drivers with 84-month car loans have a median equity of -$8,485, while those with loans under 72 months in length are in the green. 

Cars depreciate quickly, especially in the first few years, while longer loans take more time to build equity. Aim for a loan term of 48-60 months to reduce your chances of being upside-down.

2. Make a Larger Down Payment

A down payment reduces the amount you need to finance, helping you avoid starting your loan in a negative equity position. Experts recommend a down payment of at least 20% of the car’s purchase price for new vehicles and 10% for used cars to avoid being upside-down on your loan when you drive off the lot. If you can’t quite reach that goal, aim for the largest down payment that is reasonable for your budget, or consider a less expensive vehicle.

3. Avoid Overpaying for Add-Ons

Dealerships often try to upsell add-ons like theft protection, cosmetic products, and overpriced warranties and service plans. While some dealership add-ons do add value, rolling their cost into your loan is a problem. This increases your loan-to-value ratio, heightening the risk of negative equity.

Check out our Free Guide to Avoiding Dealership Add-Ons

4. Research the Vehicle’s Depreciation Rate

Some cars lose value faster than others. Luxury vehicles, electric cars, and niche models often have higher depreciation rates. Research depreciation trends to choose a vehicle that retains its value better over time. Tools like the CarEdge Depreciation Calculator and CarEdge Depreciation Rankings help you prepare.

5. Negotiate the Purchase Price

Paying less upfront reduces your risk of negative equity. Use tools like CarEdge Insights and Dealer Invoice Price to negotiate a fair price.

👉 The #1 rule of negotiating car prices is to ALWAYS negotiate the out-the-door price, which includes taxes, fees, and add-ons.

6. Avoid Rolling Negative Equity Into a New Loan

This is a surefire way to have negative equity for years into the future. Trading in a car with negative equity and rolling the balance into a new loan only compounds the problem. You’re essentially paying for two cars at once, increasing the risk of being upside-down again. 

When it comes time to trade-in, cover the difference between your previous car’s value and the remaining loan balance so that you’re not rolling over negative equity into your next purchase. This would be in addition to your down payment, which should be as close to 20% as you can get for a new car, and 10% for a used car.

7. Don’t Overstretch Your Budget

Buy a car that fits your financial situation, not one that stretches it. Luxury features and upgrades are tempting, but they can lead to higher loan amounts and greater depreciation.

8. Make Extra Payments

If your budget allows, make additional payments toward the loan principal. This accelerates equity growth and reduces the impact of depreciation. Even $10 or $20 extra each month will add up over time.

9. Consider GAP Insurance

While GAP insurance doesn’t prevent negative equity, it protects you from financial loss if your car is totaled or stolen. In the event of an accident or theft, GAP insurance covers the difference between your car’s value and the remaining loan balance. Without it, you could actually owe money after an accident that was not your fault. 

How is that possible? Without GAP coverage, here’s what could happen with negative equity at the time of an accident or theft: Your auto insurance will pay out the vehicle’s market value at the time of the loss, which may be less than the remaining loan balance. You’d be responsible for paying the difference out of pocket. With GAP Insurance, your GAP coverage would take care of the difference. 

👉 Check out our full Guide to GAP Insurance

10. Lease Instead of Buying

Leasing might be a better option if you drive less than 15,000 miles annually and don’t plan to keep the car long-term. It’s also a great option for drivers who love a new car every few years. Leasing eliminates the risk of negative equity since you’re not responsible for the car’s depreciation.

See the Best Least Deals This Month

If you’re already upside-down on your car loan, there are ways to climb out of negative equity. Here’s our complete guide to overcoming negative equity car loans.

Drive Smart With CarEdge

At CarEdge, we’re dedicated to helping car buyers avoid the pitfalls of negative equity. From DIY tools like CarEdge Insights and the new Research Hub, to white-glove, personalized car buying services, we empower you to make informed decisions. Start your journey toward smarter car ownership today with CarEdge.