Negative equity, also called being "underwater" or "upside down," means you owe more on an asset (like a house or car) than its current market value, with the debt exceeding the asset's worth. It occurs when property values drop, you make a small down payment, or your loan terms cause you to pay mostly interest early on. This situation makes selling the asset difficult, as you'd need to pay the difference out-of-pocket, and limits options like refinancing.
Example: Say you buy a $400,000 home and take out a $400,000 mortgage loan to finance it. In the months after you move in, home demand goes down in the area and your home's value drops to $390,000. In this instance, you'll have roughly $10,000 in negative equity.
In financial statements, equity represents the difference between assets and liabilities—essentially, what's “left over” for owners. When equity turns negative, it means a company's liabilities outweigh its assets. This can raise red flags, but it's important to understand the why, when, and how to respond.
Negative equity is when you owe more on your home than what it's worth. In that situation, the seller can sell the house by bringing a check to closing to cover the difference. Another common alternative is the ``short'' sale.
Negative equity -- also called an "underwater mortgage" -- is both a real financial hurdle and a state of mind.
Negative equity occurs when your home's value sinks below the amount you owe on it (from your mortgage or other home loans). Having negative equity can make it difficult to sell or refinance your home.
To get out of negative equity (being "upside-down") on a car, you can pay down the principal faster with extra payments, refinance for a better rate or term, sell the car privately for more than trade-in, or strategically handle it when buying a new car, potentially by leasing or rolling the equity into a new loan if necessary, while always aiming to stop the cycle with future purchases.
Can I Trade In a Car With Negative Equity? If you're interested in trading in your upside-down car, some dealerships will offer to pay off the loan for you.
Signs You Might Have Negative Equity
You'll save money.
Unless your loan has precomputed interest (more on that below), extra principal payments can help reduce the total amount of interest you'll pay.
By far the simplest option for selling a home with negative equity is to get as much as possible from your home sale and pay the remaining mortgage yourself. If you owe $200,000 on your home loan and sell your house for $175,000, you can pay the remaining $25,000 at the time of closing.
Negative equity occurs when liabilities exceed assets, often signaling financial distress. While it's not ideal, it can be acceptable in specific scenarios, such as during the early stages of a startup or when a company is investing heavily in growth.
This scenario is also commonly referred to as being "upside down" or "underwater" on your loan. For example, if you owe $20,000 on a car that's only worth $15,000, you have $5,000 of inequity.
Negative equity often happens if you don't put enough money down. It also occurs if you put a lot of wear and tear on your car. The car's condition can deteriorate and reduce the value. Long-term car loans that are six or seven years often lead to negative equity.
Leases are short-term (like 24 months), meaning you won't be stuck in long-term debt. At the end of the lease, your negative equity is gone, and you're free to move on.
Refinance Your Loan
If the loan term or interest is the source of your negative equity situation, then an auto loan refinance may help you get back on track. With less interest owed, you'll pay more towards the principal balance, and a shorter loan term can help you outpace depreciation.
To get out of a car loan, you can sell the car (privately or trade-in), refinance for better terms, negotiate with your lender for forbearance or term extension, or, as a last resort, consider a voluntary repossession, but be aware selling or surrendering impacts your credit, with the best outcomes usually involving paying it off or finding a better refinance deal. Always start by contacting your lender to understand your options, especially if you're struggling with payments.
What to do if you have negative equity
Dave Ramsey's core car rules emphasize paying cash, avoiding new cars (unless you're a millionaire), keeping your total vehicle value under half your annual income, and using a strict budget, often suggesting the 20/4/10 rule (20% down, 4-year loan, 10% total car expenses) as a guideline if financing, but preferring no debt at all to avoid depreciating assets trapping you. He stresses buying reliable, used vehicles to prevent debt and build wealth.
If the trade-in vehicle has $4,000 of negative equity, the dealer will pay off that loan and roll the same amount into the loan for the new vehicle. That will increase your monthly payment, and you may be able to extend the length of the new loan to make the payment more affordable.
For years, dealerships have been using a tactic called a “four square”—a sheet of paper divided into four boxes where the salesperson will write down your trade value, the purchase price of the vehicle you're buying, your down payment, and your monthly payment.
Quick Answer. If you need to get out of a car loan you can't afford, options to consider include negotiating with your lender, refinancing your loan, selling the car or voluntarily surrendering it to avoid repossession.
Dealing with Negative Equity
Wait to buy another car until you have positive equity in the one you're still paying for. For example, consider paying down your loan faster by making additional, principal-only payments. Sell your car yourself.