Americans are embracing this terrible car-buying habit. It’s costing them thousands of dollars.

Car loans keep getting longer as prices rise — and it’s costing drivers thousands of dollars more when they trade in their vehicles. – MarketWatch photo illustration/iStockphoto

Car buyers have been stretching out their loan terms to lower their monthly payments as prices for new vehicles have crept up in the last few years — with the average new-car price now approaching $50,000 and most new-car loans being six years or longer.

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This practice, however, is catching up with many drivers: Nearly 31% of vehicle trade-ins now carry negative equity, meaning the amount owed on the loan is more than the car is worth. (That amount can be paid off, offset by trade-in offers or rolled into the loan for the new car.) The share of trade-ins that are underwater is now at a five-year high as used-car values have cooled from their postpandemic highs, according to research from the car-buying site Edmunds. The uptick comes as the ongoing costs of car ownership, from insurance to maintenance to gas, have been on the rise.

The average underwater trade-in now carries $7,183 in negative equity, according to Edmunds — with the largest share, 41%, being underwater by $5,000 or less.

According to JD Power, auto loans with terms of 72 months represented 40.5% of car sales in March, while those 84 months or longer were 12.8%.

“One of the side effects of this is that equity in the vehicle builds more slowly,” which can be a costly move for those who are used to trading in their cars every three to four years, said Michael Sommer, founder of Alaminos Wealth Planning.

With loan terms this long, “it’s just not something you can dig your way out [quickly] of unless you pay off the entire car,” Ivan Drury, director of insights at Edmunds, told MarketWatch. “The only thing that saved people in prior years from not being so upside down is simply that used[-car] values were so much higher [after the pandemic].”

Related: Cars were once a financial engine of America’s middle class. Now they’re a ‘wealth killer.’

Amplifying the problem is the fact that supply-chain issues in 2022 led car buyers to pay more than the suggested retail price. Owners looking to trade in those vehicles now may face steeper-than-normal declines in value due to the inflated prices they paid at the time of purchase.

It’s a risk, especially when consumers roll over that amount into the loan for their next car, which makes the negative-equity problem worse by making the new loan larger. Car owners who roll over negative equity tend to have “lower credit scores, lower household income, longer loan terms and [are] more likely to have a co-borrower than consumers with no trade-in or a positive-equity trade-in,” according to a 2024 analysis of auto-finance data by the Consumer Financial Protection Bureau. They are also “more likely to have their account assigned to repossession within two years.”

Hold on to your car for longer

Drivers who trade in their cars at a loss are often chosing to do so because the vehicle is no longer under warranty and they “love the new-car smell,” Tyson Jominy, JD Power’s senior vice president of OEM customer success, told MarketWatch.

The clearest solution is to choose to hold on to the car for longer, as most of the depreciation happens in the first three years, and as at the start of a loan term, most of the payment goes towards interest rather than the principal.

The average age of a trade-in with negative equity is now 4.3 years, according to Edmunds. For those with less than $2,000 of negative equity, that might mean waiting another six months to a year before breaking even on their loan, Jominy said.

One rule of thumb for owners concerned about negative equity: keep a car for longer than half the term of the loan — so typically four years or more for those with 72-month loans, and longer than five years for those with 84-month loans, Jominy noted.

Buy cars that hold their value

If you want less depreciation, look at vehicles that tend to retain their value. “Usually it’s the same subset of vehicles that consistently ranks up there with best resale values,” said Drury.

In a ranking by Caredge.com, Toyota TM JP:7203, Subaru FUJHY JP:7270 and Honda HMC JP:7267 were the brands with the best resale value, while the models shown below retained the most value after five years:

More on this: These cars, trucks and SUVs keep their value better than 95% of other models

Offset negative equity with cash incentives from dealers

Car companies will often offer incentives to help their trade-in customers offset negative equity, with some brands tending to offer more because their cars depreciate faster.

“They structure their incentives to meet their customers where they are,” said Jominy. These are sometimes listed on car companies’ websites as trade-in “cash offers” or “bonus cash,” he noted.

Still, if an owner can wait to the break-even point before trading in their car, “they would get the full value of these incentives that are being offered,” rather than simply offseting the negative equity, he added.