The statement that some car dealerships make that promise to "pay off your trade" may not mean what you think it does if you owe more on your current loan than your vehicle is worth.
Car Dealers That Pay Off Your Trade-In
We're sure that you've heard or seen car dealership advertisements where they promise to pay off your trade. It's quite common for people to trade in their cars before they've paid off their old loan. Dealerships accept trades that aren't paid off all the time. They'll simply pay off your old lender to get the title so the car becomes theirs to sell.
This works out great when your old vehicle is worth more than what you owe on the loan, known as having equity. The dealer will put the difference toward your car purchase as a down payment to knock down its price.
However, when the opposite is true and your car is worth less than what you owe, you have negative equity and need to be careful about trading it in. Dealers may still accept your vehicle as a trade-in, but they won't be "paying it off."
How Trade-ins with Negative Equity are Handled
The fact of the matter is that you're going to be paying the difference back one way or another. Dealers who accept trade-ins with negative equity usually roll the difference between the value of your trade-in and what you owe on your current loan into the new loan. The amount is added to the principal and increases your monthly payment, and you'll pay interest on it because you're financing the difference, too.
Let's say you're taking out an $18,000 car loan with a 60-month term and an eight percent interest rate. In this scenario, your monthly payment would be $364.98 and you'd pay $3,898.47 in interest charges for a grand total of $21,898.47.
Now imagine you have $3,000 in negative equity under those same circumstances. Your loan balance increases to $21,000, your payment now comes out to $425.80 a month, and you’ll end up with $4,548.29 in interest charges for a total of $25,548.29.
By rolling over the negative equity, your monthly payments increase more than $60, and the total cost of the loan goes up by $3,649.82. Because of the increased expense, you always need to be careful when trading in a car with negative equity.
Understanding the Trade in Process When You Owe
Dealership advertising may make you think they'll pay off your trade no matter what you owe, but you'll still be dealing with any negative equity in some form.
If the dealer allows you to trade in a vehicle with negative equity, understand that this means financing the negative equity and increasing the cost of your new loan. You may want to explore other ways to handle it before resorting to this, such as paying the difference out of pocket, buying a new car with a manufacturer rebate that's large enough to make up the difference, or waiting to buy until you're in a better equity position.
Understanding what dealerships mean when they say they'll pay off your trade and how negative equity is handled during the trade in process can help you make more informed choices. To avoid a situation in which you end up paying more than you expected, make sure you:
- Head into the trade in process knowing your equity position by researching your car's value and your current loan payoff amount beforehand.
- Understand the details of how your trade-in and any negative equity are being handled by carefully reading the contract before you sign.
The Bottom Line
Promises to pay off your trade may sound too good to be true when you owe more money on your loan than your car is worth – because they are. With a little prep work and knowledge of the trade in process when you have negative equity, you'll understand the consequences and can eliminate surprises.
If you're looking for a car dealership that can get you financed, Auto Credit Express can help get you connected to one in your area. We work with a network of dealers that specialize in helping car buyers with less than perfect credit. Fill out our fast and free auto loan request form right now to get the process started.