It may be even harder to get out of an auto loan if your trade in is worth less than the loan balance and you have problem credit
Trade in problems
While it can be a problem even with good credit, car buyers with bad credit will find it especially difficult getting out of a car loan if they owe more on their current vehicle than it appraises for.
We know this for a fact here at Auto Credit Express because we've spent the past two decades helping poor credit car buyers find those dealers that can give them their best opportunities for auto loan approvals.
It's also a problem that will only be getting worse, as a recent report from Experian Automotive noted that car buyers are increasingly choosing longer loan terms.
For most buyers, however, there is very little concern about this issue until the time comes to trade a vehicle in and it needs to be appraised.
Vehicle appraisal process
During the appraisal process, the car dealer determines the value of the vehicle to be traded in based on its age, condition and mileage.
It's at this point that consumers are often surprised that what they're currently driving isn't worth as much as they thought – despite the fact that online used car values are readily available from sources such as NADA and Kelley Blue Book. In this case, while NADA and Kelley Blue Book values are helpful, they should only be considered as a general guide.
Real time auction values from sites such as Mannheim and available only to dealers are usually more accurate. Add to this the fact that, in doing their own online evaluations, owners typically don't take into account reconditioning expenses such as detailing and the replacement of worn and broken parts. These are all expenses that the dealer will have to incur in order to sell a vehicle that have to be taken into consideration when determining its value.
The next step is to determine the owner's equity in the vehicle. Equity, in this case, is the difference between a car's value and any balance owed on it.
If it's paid off, the entire appraised value is considered to be owner equity. If a vehicle isn't paid off but the appraised value is greater than what is owed, the difference is owner equity. If the appraised value is less than what is owed, then the difference is referred to as negative owner equity or just "negative equity."
Since high risk auto lenders typically require "participation" in the form of a down payment, if you're trading in a vehicle with no additional money down there needs to be enough equity in it to meet the down payment requirements. If there isn't, the difference needs to be made up with additional cash down.
But if the trade is a wash (its value equals the loan balance) or it's worth less than the appraised value, then the total cash down payment must either equal the down payment requirement (if a wash) or even go beyond the down payment requirement by an amount that equals the negative equity figure of the trade in.
Even if the lender allows a negative equity trade in without covering the entire difference – which rarely happens – the borrower will end up paying for that negative amount, plus the balance on your new car, plus the interest on both. This situation goes from bad to worse with the higher interest rates charged to credit-challenged borrowers.
The right circumstances
So when does getting out of a car loan under these circumstances make sense?
If the lender allows it or if you have the money to cover the difference, you should only consider a negative equity trade if it ends up saving you money.
In fact, there are two situations in which it might:
1. If your car is out of warranty and the necessary repairs will cost more than you'd spend on the increased cost of the new loan
2. If the additional cost of the new loan will be offset by lower fuel and/or insurance expenses
If neither situation exists, you'll only be adding to your debt. It's also an even poorer decision if your FICO scores are low.
The Bottom Line
Trading in your current car can help reduce the interest expenses on any type of auto loan if it's paid off or you have equity in it. But if you have a negative equity, trading it in only makes sense if you're trying to avoid costly repairs or if you can offset an increase in personal debt with a corresponding savings in fuel and/or insurance-related expenses.
One more suggestion if you have bruised credit and you're shopping for a car: Auto Credit Express specializes in helping consumers with damaged car credit find those dealers that can give them their best opportunities for approved auto loans.
So if you're ready to reestablish your auto credit, you can begin now by filling out our online auto loans application.