Alabama Couple’s $40K Car Loan: A Lesson in Financial Risk

Katie and her husband earn a combined $147,000 annually, which is nearly double the average U.S. household income of $74,000. Despite their high income, they find themselves in a difficult financial situation: they are “upside down” in car debt. The 41-year-old reached out to The Ramsey Show for guidance, explaining that she’s been working overtime every week to pay off debt and has significantly trimmed her lifestyle.

The couple, along with their twin 15-year-old children, lives in Alabama. Katie mentioned that they’re following Baby Step 2 of the Dave Ramsey method — paying off all debts, starting with the smallest. She had a $6,000 payment ready to send toward her credit card debt, which made it seem like she was on the right track. However, she then revealed a major issue: a $40,000 car loan.

“I forgot about the car,” she admitted to co-hosts George Kamal and Jade Warshaw. “That’s the whole reason I’m calling.”

The couple purchased the car brand new during the pandemic, but Katie estimates its current value at only $27,000. This means she’s $13,000 underwater on the loan, and if she were to trade it in, she would receive less than what she owes. To make matters worse, she’s been living without a functioning kitchen for a year and has already spent $50,000 from the sale of a previous home to cover emergency home repairs.

While Katie’s situation is extreme, she’s not alone in facing challenges with car loans and uncertainty about whether to keep the vehicle or pay it off.

Car Loans Exert More Stress on Americans’ Budgets

Katie’s $13,000 problem isn’t an isolated case; it reflects a broader trend in the car loan industry. Since 2020, new vehicle prices have risen by 33%, with the average price surpassing $50,000 for the first time, according to Kelley Blue Book. To afford these higher costs, many buyers are stretching their loan terms, making six-year-plus financing more common.

This results in monthly payments averaging around $760, and an increasing number of drivers who owe far more than their cars are worth. A new car can lose up to 20% of its value in the first year alone, which can quickly put borrowers in a deep hole if they financed most or all of the purchase price.

According to Edmunds’ Q3 2025 data, over one in four new-vehicle trade-ins were underwater, marking a four-year high. The average amount owed on those loans hit a record $6,905, with nearly one in four borrowers owing more than $10,000 — also a record.

What makes the situation worse is that many buyers roll their negative equity into their next car loan. While this may seem like a solution, it often leads to deeper financial trouble.

What to Do If You’re Underwater on a Car Loan

The best way to avoid being underwater on a car loan is to never get there in the first place. When shopping for a car, ensure you have enough savings for a large down payment so you don’t end up in a position where your car is worth less than what you owe.

Additionally, avoid stretching into long-term loans just to make payments feel manageable. Instead, look for a lower-cost car and focus on the full cost rather than just the monthly payment.

If you’re already underwater, consider the following options:

• Stay and pay it down: If you can afford the payments and the gap isn’t too large, keeping the car and aggressively paying down the principal is a viable option. This works best when you’re only slightly underwater and the car is reliable.
• Sell the car and cover the difference: This is the approach Kamal and Warshaw suggested for Katie. Sell the car for its current value and take out a small personal loan to cover the negative equity. From there, consider purchasing a reliable used car for around $5,000. Once the loan is paid off, you can explore upgrading your vehicle — this time, in cash.
• Refinance carefully: If interest rates have dropped, refinancing could reduce your monthly payment and overall cost. However, refinancing doesn’t eliminate negative equity. Extending your loan term to lower payments might actually make you more underwater, so be sure to calculate the numbers before committing.
• Don’t roll it over: Avoid rolling negative equity into your next car loan. This may seem tempting, but it means your next loan will likely be underwater before your first payment.

As for deciding which option is best for you, Kamal’s advice to Katie offers a useful framework: evaluate how much you spend on vehicles as a percentage of your household income. Ramsey suggests that the value of everything you own with a motor shouldn’t exceed half your annual take-home pay. So, if you earn $100,000, your car should be worth less than $50,000. If your vehicle exceeds this threshold, especially while trying to pay off other debt, it may be time to downsize.