Negative car equity is higher among borrowers with lower income and credit scores: CFPB

Drivers with negative equity auto loans are twice as likely to have their accounts assigned to repossession, have lower incomes and have lower credit scores, a recent Consumer Financial Protection Bureau (CFPB) survey said.

Negative equity or being underwater on a car loan means that what a borrower owes on financing exceeds the vehicle's value. The risk for consumers is that when they want to get a new car, they will need to cover the negative equity with their new loan, or they will have to stay in their current vehicle longer. Roughly 11.6% of consumers financed negative equity from an existing loan into a new loan, according to the survey of new and used-vehicle loan data from 2018 to 2022, according to the survey. The mean negative equity amount on the loans was $5,073 for new vehicle financing transactions and $3,284 for used vehicle financing transactions.

A separate report by Edmunds said that by the first quarter of 2024, auto sales with a negative equity trade-in increased to 23.1%, with the average negative equity value reaching an all-time high of $6,167. These loans are more significant, with higher monthly payments and interest rates than transactions with positive equity or no-trade-ins.

Negative equity loans continue to increase because prices for both new and used cars are normalizing after hitting record highs during the COVID-19 pandemic.

"This means that for consumers who purchased new or used cars at or near the height of the market, the values of their vehicles have declined at a rapid pace," the CFPB said.

Moreover, borrowers with negative equity loans tended to have an average credit score of 704, compared to 752 for loans with positive trade-in and 732 for those consumers with no trade-in associated with the account, the survey said. Additionally, these consumers had a higher payment-to-income ratio and were less likely to be able to handle a financial shock.

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Loan APRs continue to increase

The average auto loan annual percentage rate (APR) for used cars in the first quarter of 2024 remained above 7% for the fifth consecutive quarter, according to the Edmunds report. For used-vehicle APRs, it rose one-tenth of a percentage point to 11.7% over the previous quarter.

Drivers paid an average of $735 monthly to finance new cars, just $4 below last quarter. Used-vehicle monthly payments dropped to $546, down from $561 in the previous quarter and $551 one year ago. However, car owners who decide to roll an outstanding balance of an existing car loan into a new car purchase are spending more. The average monthly payment for a new vehicle that included a trade-in with negative equity was $887. These drivers also paid a higher average APR of 8.1%.

"Compelling new product launches combined with the reintroduction of incentives and rebounding inventory in the new vehicle market are all positive signs for shoppers, but elevated interest rates have dampened any positive market momentum," Jessica Caldwell, Edmunds' Head of Insights said. "The resurgence of negative equity is only compounding the affordability challenges, as consumers who regretted their pandemic-induced purchases are now encountering lower-than-expected vehicle values when returning to dealerships for a new purchase."

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Tips for avoiding negative equity

Since most vehicles are considered depreciating assets, many consumers are familiar with negative equity, regardless of the economic environment. However, rapidly declining prices and normal depreciation have compounded the risk of negative equity.

Consumers buying a car at a premium can opt to put more money down to avoid a negative situation and borrow less. Another option for consumers is to hold onto the vehicle for longer and avoid trading in or selling their cars until they are no longer underwater on the loan.

"The monthly payment might be a tolerable amount, but it's critical for consumers to consider all elements of their loan when financing a car purchase in 2024," Ivan Drury, Edmunds' director of insights said. "And once you're locked into a loan, try to avoid the temptation of trading that vehicle in too soon.

"Factors like gas prices, vehicle maintenance costs and work commute changes may feel like reasons to trade in your keys for a shiny, new ride, but a new high-dollar car payment with a high interest rate tied to existing negative equity should serve as a rationale for pumping the brakes," Drury continued.

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