How this happens:

• Subprime borrowers get a high interest rate on the loan;
• Borrowers buy more “car” than they can really afford, so to lower the monthly payments, they choose loan terms up to 6 years long;
• Or car owners want a new car within a few years of purchasing the last new car, and in order to finance the new purchase, they tack on the extra payoff of the first loan to the subsequent purchase money loan.

In each instance, the bottom line is that the owner of the car doesn’t build an equity position in the car’s ownership until relatively late in the game. This, coupled with the quick depreciation rate in almost all consumer vehicles, yields a situation where the owner owes more than the car is worth. If the car sells for $10,000 but the payoff is $14,000, then the owner must come up with the extra $4,000 somewhere else.

Strong equity positions are good things, be they in homes or in cars, and so the upside-down loan, or negative equity position, puts the owner in a weaker circumstance. To avoid this, car buyers can either structure their acquisitions more carefully, explore leasing as an option, or — an option this article doesn’t seem to mention — purchase a less costly used vehicle.