Why High Loan-to-Value Auto Loans Can Be Problematic

Certain types of loans can lead to unexpected costs and risks.

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More and more car buyers across the U.S. are grappling with high loan-to-value (LTV) ratios on their auto loans for both new- and used-car purchases.

LTV ratios are key indicators of potential risk that auto loans pose to both borrowers and lenders, including risks associated with negative equity. Negative equity results when your car's value is less than the amount owed on the loan. If your LTV ratio goes above 100%, you risk possibly owing your lender more than what your car is worth.

A recent study from Transunion and J.D. Power shows a growing trend of high loan-to-value ratio auto loans, making it important for car buyers to understand what this ratio means and why elevated ratios could be problematic.

Understanding Loan-to-Value Ratios

The loan-to-value ratio of your auto loan is represented by a percentage calculated by dividing the amount you will borrow from a lender, or loan principal, by the current value of your vehicle. This ratio is used by lenders as a way to evaluate potential default risks and whether the lender will be able to collect on the full amount of the debt secured by the car as collateral if there is a default.

Lenders want to know if they can make their money back by selling your vehicle if you default on the loan payments.

Your starting ratio will depend on your auto loan amount in relation to your car's purchase price and won't necessarily start at 100%. In fact, with a down payment, your ratio will likely start at less than 100%.

The less you borrow compared to your vehicle's value, the lower your loan-to-value ratio will be. You can lower your loan-to-value ratio even further by increasing your down payment, which could lead to better loan terms or better approval odds.

How to Calculate LTV

To calculate your loan-to-value ratio as a percentage, you can use the following formula: The loan amount divided by the fair market value of the car and then multiplied by 100.

For example, if you took out a $15,000 auto loan for a car of equal value, your loan-to-value ratio would be 100%. Some loans may even start at higher than 100%, as some lenders are willing to offer loans with ratios of 125% or more.

What a High LTV Auto Loan Looks Like

When your loan-to-value ratio goes above 100%, it may be considered high by some lenders' guidelines. A higher than 100% loan-to-value ratio means that you owe more on your loan than the vehicle is currently worth. Whether that's due to depreciation or even the factoring in of extra fees and taxes, high loan-to-value auto loans can occur for a variety of reasons.

One particularly risky cause of these high loan-to-value ratios is when drivers roll negative equity from one loan into a new loan. Some borrowers may choose to do this instead of paying off the difference on their previous loan. As an example, picture someone trading in a car for which they still owe $5,000 on their loan. That $5,000 then gets added to the new balance for the newly purchased vehicle.

By rolling negative equity from an existing loan into a new loan for a different vehicle, car buyers drive up their loan-to-value ratio and potentially increase their chances of default.

What High LTV Auto Loans Can Mean for Borrowers and Lenders

Vehicle prices increased dramatically during the pandemic due to inventory issues, leading many car buyers to secure loans with high monthly payments associated with increased vehicle values. As time went on and vehicle values declined, loan-to-value ratios began to shift out of the borrower's best interest.

According to the joint study from TransUnion and J.D. Power, loan-to-value ratios have been on the rise for both new- and used-car buyers over the past three years — with used-car buyers facing a particular disadvantage. The data reveals that the average LTV ratio for used-car buyers rose from 112% in the first quarter of 2020 to 125% over the same period of 2023.

For borrowers, the higher the loan-to-value ratio, the less equity they have in a vehicle. In addition to potential difficulties making payments, this could also make it more of a challenge for drivers to pay off their auto loans if they're involved in an accident or want to sell their vehicle.

Not only does this shift in loan-to-value ratios put borrowers at an equity disadvantage, it also poses a risk of increased defaults for lenders, making creditors less likely to lend.

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Elliot Rieth
Elliot Rieth is a writer who was born and raised in Michigan, the center of the American automotive industry. With a background in the industry that spans from sales to digital marketing, Elliot has years of experience working directly with dealers and OEMs to create digital content and educate potential customers. When Elliot isn’t writing about horsepower or EVs, he can be found with his two greyhounds enjoying a new book or record.