Negative equity, often referred to as being 'upside down' or 'underwater' on your car loan, occurs when the outstanding balance you owe on your current vehicle is greater than its actual market value at the time of trade-in. This situation typically arises due to rapid depreciation of the vehicle, a small down payment on the original purchase, a long loan term, or high interest rates, all of which mean you've paid less off the principal than the car has lost in value. In the Canadian market, particularly looking towards 2025, while used car values have seen fluctuations, rapid depreciation remains a significant factor, especially for newer models, and higher interest rates exacerbate the challenge of building equity quickly.

When you trade in a vehicle with negative equity, the deficit is almost always 'rolled over' or added to the principal of your new car loan. This immediately inflates your new loan amount, leading to higher monthly payments, a longer repayment period, and significantly increased total interest paid over the life of the new loan. For Canadian consumers, this matters immensely as it creates a cycle of debt, making it harder to build equity in future vehicles and potentially limiting your options for future trade-ins. It also puts you at financial risk; should your new vehicle be stolen or declared a total loss, your insurance payout might not cover the inflated loan balance, leaving you responsible for the difference. Ultimately, negative equity limits your financial flexibility, increases your overall cost of vehicle ownership, and can make it challenging to exit a car loan without incurring further debt.