When the Car Is Worth Less Than the Loan
Auto loan delinquencies are climbing at a pace that is starting to make lenders uncomfortable, and the timing could not be worse. Used car prices, which surged to historic highs during the supply chain disruptions of 2021 and 2022, have been correcting steadily downward. That correction is now colliding with a wave of borrowers who financed vehicles at peak valuations and are now underwater on loans tied to assets that have lost significant ground.
The mechanics of the problem are straightforward. A borrower who paid $35,000 for a used truck two years ago, financing most of it at elevated interest rates, may now find that the same vehicle is worth $24,000 or less on the open market. Missing a payment does not just hurt their credit score – it puts them in a position where selling the vehicle would not cover the remaining loan balance, eliminating the easiest exit from financial distress.
Negative equity traps are not new, but the scale of this cycle is unusual.
How the Used Car Bubble Set the Stage
During the pandemic-era chip shortage, new vehicle production slowed dramatically, pushing buyers into the used car market and sending prices to levels that defied historical norms. Dealers were selling used vehicles above sticker, and lenders extended credit generously against those inflated valuations. Many buyers stretched their budgets because monthly payments felt manageable when interest rates were still near zero. The problem is that rates did not stay near zero.
As the Federal Reserve raised benchmark rates aggressively through 2022 and 2023, the cost of auto credit rose sharply. Borrowers who locked in loans at 7, 8, or even 10 percent on vehicles that were already overpriced faced a compounding squeeze. Wages did not keep pace for a broad swath of middle-income earners, and monthly obligations that once felt tight became genuinely unmanageable for many households carrying multiple forms of consumer debt. Credit card balances and student loan resumptions added pressure on the same budgets.
The used car market has since corrected, but it has not corrected cleanly or uniformly. Sedans and compact cars have held value better than trucks and SUVs in certain segments, while electric vehicles have seen some of the steepest depreciation as the new EV market expanded and early-adopter premiums evaporated. A borrower’s outcome depends heavily on what they bought and when, but the directional pressure is the same across categories: the asset is worth less, and the loan is not shrinking fast enough to close the gap.
Lenders Are Watching, and Starting to Tighten
Delinquency data from auto lending portfolios has been flashing yellow for several quarters. Subprime borrowers – those with credit scores typically below 620 – are seeing the sharpest deterioration, with 60-day delinquency rates creeping toward levels that rival the stress seen during earlier economic downturns. But the pressure is not confined to the subprime tier. Near-prime borrowers, those in the 620 to 680 range, are also showing increased stress, which suggests the issue extends beyond the most financially fragile segment of the market. This is worth watching because near-prime defaults can signal broader household financial strain in ways that subprime data alone does not capture.
Lenders are responding by tightening underwriting standards. Loan-to-value ratios are being scrutinized more carefully, meaning lenders are less willing to finance 100 or 110 percent of a vehicle’s appraised value. Income verification requirements are getting stricter at some institutions. These adjustments are rational credit risk management, but they also have a secondary effect: they make it harder for borrowers in distress to refinance their way out of a bad loan, which is exactly the kind of lifeline that can prevent a delinquency from becoming a default and repossession.
Repossession activity has picked up noticeably. Auction lanes are seeing higher volumes of repossessed vehicles, which creates a feedback loop – more repos hitting the used car market means more supply, which pushes used car prices down further, which deepens negative equity for everyone still holding an underwater loan. This dynamic does not resolve quickly. It tends to grind through the system over multiple quarters as loans season and defaults work their way to resolution. The slowdown in reemployment rates for displaced workers adds another layer of pressure, since job loss is the most common trigger for an auto loan default.
No Clean Exit in Sight
Used car values would need to stabilize or recover meaningfully for the negative equity problem to ease, and there is no strong catalyst for that on the near-term horizon. New vehicle inventory has largely normalized, removing the supply-shock that drove used prices up in the first place. Electric vehicle adoption continues to expand, putting pressure on used EV prices specifically and reshaping resale value expectations more broadly. Meanwhile, borrowers who are already delinquent are running out of options: they cannot sell, refinancing is harder to obtain, and repossession leaves them without transportation and with a deficiency balance – the gap between what the vehicle fetches at auction and what remains on the loan – that does not disappear when the car does.
