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Buying a car hinges on being able to afford it. And that’s gotten a lot tougher at post-pandemic prices.

To keep monthly car payments manageable, some buyers are choosing to finance their purchase over a longer period of time, accepting additional interest costs as the tradeoff. This has become steadily more popular, with 23% of last quarter’s new car buyers taking out loans for seven years or more — a record share, according to data analyzed by Edmunds, an online car shopping guide.

The thing is, borrowing for longer has a second less-obvious downside: If you trade your car in for a new one while you’re still paying your loan off, you could end up owing more than the vehicle is worth.

In fact, 31% of people who got a new car last quarter were in this boat — the most in five years, according to Edmunds. Worse, they owed almost $7,200 more than their car’s value, on average. That’s 42% more debt than underwater trade-ins faced five years ago, and just shy of the heaviest debt burden ever.

Being “underwater” on a loan isn’t a new concept, but it’s been a growing challenge since 2022. Used cars aren’t maintaining value like they were during the car shortage triggered by the pandemic. But the average new car still costs over $49,000 — about $10,000 more than pre-COVID — making the monthly math a struggle for more people. Plus, interest rates have been relatively high the past few years (and tend to be higher on longer loans).

Think of the problem this way: New cars typically lose the most value in the early years. And the whole point of a longer loan is to lower your monthly payment, which slows your payoff progress. These competing forces make it harder for people to break even on a trade-in before they’ve paid off their loan.

So what?

Rolling old car debt into your next loan is a bit like starting a road trip with the parking brake engaged (and stuck in the on position). The process can even create a cycle of debt. A buyer’s negative equity can completely absorb what would otherwise be a new down payment, creating an even bigger new car loan with a potentially higher interest rate.

Limiting yourself to a four- or five-year loan could potentially help you avoid this trap, so it’s worth exploring whether buying a cheaper vehicle can make that possible. As an incentive, consider this: If you end up rolling negative equity into a new loan, you’re likely to pay more per month. Last quarter those buyers signed up to pay $932 a month, while the average was $773, according to Edmunds.

Here are some other strategies for navigating around a negative-equity cycle:

Keep your current car longer. The simplest way to avoid going underwater is to delay plans for a new car. If possible, hold onto your current vehicle until you’ve paid enough of your loan balance to be in positive equity territory. Of course, if your vehicle isn’t reliable or you need a different type of car (for a new baby, for instance), that may not be an option.

Make extra principal payments when you can. If you pay more than the required payment whenever you can afford it, you’ll get above water faster and save on interest costs over time. Just make sure the extra money is applied to principal, not future scheduled payments.

Sell your car yourself. You may be able to get more than what a dealer says it’s worth, according to the Federal Trade Commission.

Refinance your loan. If prevailing interest rates have fallen since you took out your loan — or your credit score has gone up — explore whether refinancing could lower your rate and help you build equity faster. Just make sure any potential savings would offset lender fees.

Go into any trade-in with your eyes open. First check your loan’s “payoff amount” (which is not always the same as the outstanding balance on your statement). Then compare it with trade-in estimates from a variety of sources like Kelley Blue Book, Carvana, Consumer Reports, or Edmunds. If your trade-in value falls short, you know you’ll be bringing debt into the next deal. But shop around, since different dealers can give you different deals.

Limit the downside. If you end up rolling negative equity into a new loan, ask the dealer how they handle it and make sure the contract matches what they’ve said before you sign it. You’ll also want to negotiate the shortest loan you can afford.

Related Reading

Should You Pay Off Your Car Before Trading It In? (SoFi)

How to Get the Best Car-Loan Rate Despite a Low Credit Score (Consumer Reports)

Lower-Income Americans Are Missing Car Payments (The Economic Times via MSN)

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