Picture a member who financed their truck three years ago on a 72-month loan. Today they want to trade it in, but they owe $8,000 more than it’s worth. To get into the next vehicle, it means rolling $8,000 into a new loan, setting the clock back to zero. This isn’t an edge case. It is increasingly the norm, and it is reshaping the risk profile of auto portfolios across the country.
Auto lending remains a cornerstone of credit union growth, but the foundation is shifting. Rising vehicle costs, record loan balances, and the rapid expansion of longer-term financing are creating a structural increase in negative equity that is reshaping both borrower behavior and portfolio risk.
Recent data confirms the scale of the shift. The average amount financed for a new vehicle reached a record $43,899 in Q1 2026 — nearly $44,000 committed to an asset that begins losing value the moment it leaves the lot¹. Monthly payments have climbed alongside that figure, and nearly one in five borrowers is now committing over $1,000 every single month just to keep a vehicle in the driveway.
When that payment is attached to a seven-year loan on a depreciating asset, it is not simply a financing decision. It is a financial trap that is becoming harder and harder to exit. These are not isolated data points. They reflect a broader change in how vehicles are being financed and what it takes for borrowers to remain in the market.
To manage rising costs, borrowers are increasingly turning to longer loan terms. Loans of 84 months or more now represent a growing share of originations, rising sharply in recent years. In some segments, particularly trucks and higher-trim SUVs, extended terms are becoming the default because they are often the only way to achieve a target monthly payment. For credit unions, this raises an important strategic question: are longer terms solving the affordability problem, or simply pushing risk further into the future?
Negative Equity Is Becoming More Common
Negative equity has long been a part of auto lending. What is changing is how persistent and widespread it has become — and how deeply its roots trace back to the pandemic.
During the pandemic, a semiconductor shortage created a severe shortage of new vehicles on dealer lots. Prices soared, and buyers, either flush with disposable income or lacking other transit options, paid up. That wave of inflated purchases is now coming back around. As those borrowers attempt to trade in, they are discovering that their vehicles are worth far less than they owe.
According to a recent Wall Street Journal analysis, about 30% of borrowers who traded in a vehicle in Q1 2026 carried negative equity, with an average shortfall of $7,200 — a 42% jump compared with the same period five years earlier⁷. Borrowers with negative equity financed an average of nearly $56,000 for a new vehicle in Q1 2026, roughly $12,000 more than the typical buyer, resulting in average monthly payments of $932 — the highest ever recorded.
The downstream consequences are significant. Consumers who rolled over negative equity from a prior vehicle loan were more than twice as likely to have their car repossessed within two years, compared with those who netted money on a trade-in, according to a 2024 study from the Consumer Financial Protection Bureau⁷. Default rates on car loans rose in March 2026 to their highest levels since 2010.
At the same time, affordability pressures are not easing. Used vehicle prices have recently increased by approximately $1,500 in a short period, adding further strain to both new and pre-owned buyers. As more consumers shift toward used vehicles to manage costs, they are encountering many of the same challenges.
The Trade-Off Behind Longer Terms
Extending loan terms has become the primary tool for maintaining affordability. It works in the short term by lowering monthly payments. However, it introduces longer-term risks for both borrowers and lenders.
Borrowers remain in negative equity positions for a longer portion of the loan. The likelihood of rolling that negative equity into the next transaction increases. Credit unions, in turn, carry exposure on depreciating collateral for extended periods.
In effect, longer terms address payment, but not financial sustainability. This creates a difficult balancing act. Without competitive payments, credit unions risk losing volume to dealerships and captive lenders. But relying solely on longer terms can increase portfolio risk and limit future lending opportunities.
A Structural Alternative To Extended Terms
Addressing affordability without compounding risk requires a different approach. Residual-based financing offers an alternative structure that changes how vehicle loans are built.
Instead of making payments on the full loan amount, monthly payments in a residual-based structure are calculated on the difference between the purchase price and a guaranteed future value set at origination. The result: lower payments without adding months to the term. At maturity, borrowers can keep the vehicle, refinance, trade, or walk away — a clean exit that breaks the negative equity cycle rather than extending it.
This shift creates several advantages. Borrowers can achieve lower monthly payments without extending terms beyond typical ranges, often 24 to 72 months. At the end of the term, they have clear options: keep the vehicle, refinance, trade, or return it and walk away from the remaining balance. Most importantly, this structure helps reduce exposure to negative equity by aligning the loan with expected vehicle value over time.
Supporting Both Member Outcomes And Portfolio Performance
For credit unions, improving affordability is not just about originating loans. It is about ensuring those loans perform over time. When borrowers are placed into payments they can realistically afford, the benefits extend beyond the individual transaction. Lower payment stress can contribute to stronger repayment behavior, improved member satisfaction, and more stable portfolio performance.
Residual based financing also provides a way to compete more effectively in a payment-driven market. Dealerships and captives continue to focus heavily on monthly payment as the primary decision factor. Without comparable options, credit unions risk losing relevance in both direct and indirect channels. By offering an alternative to extended-term financing, credit unions can maintain competitive positioning while managing risk more effectively.
Residual-based financing also delivers a meaningful yield advantage for credit unions because the loan amortizes to the guaranteed future value rather than to zero. This produces a higher effective yield compared to a conventional loan of the same term, an outcome that supports portfolio performance alongside the member benefits.
Expanding The Lending Toolkit
One of the more telling dynamics in today’s market is that many borrowers are not choosing longer loan terms because they want to. They are choosing them because they feel they have no other option. That perception presents an opportunity. Residual-based financing introduces another lever for managing affordability — one that does not rely on extending loan duration or increasing borrower risk. It allows credit unions to structure loans more strategically, balancing payment, equity position, and portfolio performance.
Looking Ahead
J.D. Power analysts have explicitly warned of a “day of reckoning” as negative equity balances and long-term loan exposure accumulate across lender portfolios. That language is striking because it signals not a gradual shift but a potential inflection point. The credit unions best positioned for what comes next will be those that moved before the pressure became acute, not those still extending terms and hoping the market stabilizes.
Negative equity is becoming more embedded in the auto finance system, driven by rising vehicle costs, higher payments, and the growing reliance on extended loan terms. Addressing this challenge requires a shift in approach.
By incorporating alternative structures such as residual-based financing, institutions can help members avoid or exit the negative equity cycle while maintaining competitive positioning and supporting long-term portfolio health.
The goal is not simply to make the next payment work. It is to ensure that each loan puts the member in a stronger position for the next financial decision.
If your credit union is still relying solely on term extension to compete on affordability, you are solving today’s payment problem while building tomorrow’s portfolio risk. Join us on May 19 to explore a different path.
Register for our live webinar, Beyond Conventional Auto Lending: The Advantages of AFG Residual-Based Financing, on May 19 at 1 p.m. CT / 2 p.m. ET, where we’ll explore how residual-based financing works and how it can help your credit union address affordability challenges, reduce negative equity exposure, and strengthen portfolio performance.
Auto Financial Group (AFG), a Houston-based company, provides an online, residual-based, walk-away vehicle financing product called AFG Balloon Lending, as well as vehicle leasing and vehicle remarketing to financial institutions across the United States. For more information about AFG, call toll free at 877-354-4234 or visit www.autofinancialgroup.com.
Tim Kelly is president and chief operating officer of Auto Financial Group. He has more than 25 years’ experience delivering solutions to financial institutions. Contact him at tkelly@autofinancialgroup.com.
