Your money adviser: How to buy a car when you have an upside-down loan

More people who trade in their car when buying a new vehicle are "upside down," meaning that they owe more on their old auto loan than the car is worth, the automobile website Edmunds.com says.

Edmunds estimates that 32 percent of trade-ins for new-car purchases in the first nine months of this year had "negative equity," up from 30 percent for the same period last year. The upside-down shoppers had average negative equity of more than $4,800 at the time of trade-in, which Edmunds said is the highest since it began tracking such data in 2002.

About a quarter of trade-ins from shoppers buying used cars also had negative equity, averaging $3,600, Edmunds said.

Being upside down on a car loan is akin to being underwater on a mortgage, in that the asset securing the debt is worth less than the loan. Say that you owe $20,000 on a car now valued at $18,000. That means you have negative equity of $2,000. If you trade in your vehicle for a new car, you must make up that $2,000 somehow — either by writing a check or rolling the amount into your loan on the new car. It will then take longer to build equity in the new loan, too, meaning you could get stuck in a cycle of loans with negative equity.

Several factors are converging to create negative equity, said Ron Montoya, senior consumer advice editor with Edmunds. New cars have always lost value quickly; it begins as soon as they are driven off the dealer's lot. But now, as cars have become more expensive, auto loans are several years longer than they once were. The average new-car loan for borrowers with good credit is now 68 months — 5 ½ years — while the average used-car loan is 63 months, according to data from Experian Automotive.

"It's a symptom of long-term loans," Montoya said.

The estimated average new-car price was nearly $35,000 in October, up more than 2 percent from a year earlier, according to Kelley Blue Book. And the average loan amount for a new car was about $30,000, up from nearly $29,000 a year earlier, second-quarter data from Experian showed.

"A long-term loan doesn't necessarily keep the consumer in the car longer," said Melinda Zabritski, senior director of ­automotive finance at Experian.

Being upside down may not pose a problem, as long as things are going well. But if you had an unforeseen financial setback and had to sell the car, you might have to come up with extra cash at a time when you may not be flush. Or, if your car is wrecked or stolen, you might find your insurer won't pay out enough to retire the loan, said Tony Giorgianni, associate money editor for Consumer Reports.

If you find yourself upside down on your car loan, the most financially sound thing to do is to hang on to your old car until you pay down the debt enough to have equity. To do so faster, you can make extra payments toward the loan's principal.

Still determined to get a new car? You could look for incentive offers, like cash-back rebates, that could help cancel the effect of the negative equity, Montoya said.

Here are some questions and answers about car loans:

A: When shopping, consider whether you really can afford the model you want to buy. If it's necessary to take out a six-year loan to afford the monthly payment, it may be wise to choose a less expensive ride, said Giorgianni. A rule of thumb is 20-4-10: Put at least 20 percent down in the form of cash or a trade-in, finance the car with a loan of no more than four years and make sure the monthly expenses, including the car payment and insurance costs, are no more than 10 percent of your gross income.

Montoya of Edmunds also suggests taking more than a single short test drive before settling on a car to reduce the chance of buying an unsuitable model that you will want to trade in when you're more likely to be upside down.

Q: How can I calculate the cost of an upside-down trade-in, when taking out a new loan?

A: Bankrate.com offers a negative equity calculator on its website.

Q: How can I be sure I am treated fairly when trading in an upside-down car?