It's common to trade in a vehicle before it's paid off, but the situation gets tricky if the car is worth less than what you owe on it.
How a Trade-in Works When You Still Owe
People prefer (or need) a different size or type of vehicle for many different reasons, from family additions to changes in income. No problem. Car dealers are happy to take a trade-in before it's paid off.
Make no mistake – you still need to pay off the original loan to remove the lien from the car, but the dealership will generally do that as part of the trade-in process. You’ll want to know the payoff value of the loan (which you can get from your existing lender) before the dealership appraises your car to determine its actual cash value.
For example, let's say you owe $7,000 on your loan and the dealership will give you $9,000 for your trade-in. The dealer will take in your car, pay off your existing lender, and give you the remaining $2,000 to either keep or put toward your purchase. Not a bad deal.
However, you can run into problems when the opposite is true. Let's flip the script and say you owe $9,000 on your loan but the dealership's offering you $7,000 for your trade-in. Now, you're responsible for the $2,000 difference, which can throw a wrench into the trade-in process.
The Problems with Negative Equity
The difference between what your vehicle is worth and how much you owe on it is known as equity. But when your loan balance is higher than the trade-in value of the car, this is known as negative equity (commonly referred to as being upside down or underwater). Negative equity is quite common these days – where vehicle prices are high and long loan terms are common – due to depreciation, interest charges, and other factors.
You may have seen or heard dealership advertisements that promise they'll take your trade-in no matter what you owe. This can be misleading. While dealers are happy to accept trade-ins with equity, they (and their lending partners) treat negative equity much differently.
If – and we emphasize "if" – the lender allows you to trade in a vehicle with negative equity, the difference between what you owe and what your car is worth isn't going away. Instead, the balance will be rolled into your new loan, which causes a few problems:
- The balance increases the size of your new loan, leading to higher monthly payments and increased interest charges.
- It could limit your financing options, as the inflated balance could lead you to be unable to qualify for certain loan programs or vehicles.
- This automatically leads to even more negative equity in your new loan because the car you finance will instantly be worth less than your loan balance. This often leads car buyers to the same dilemma the next time they need a vehicle, so it can trap them in a repeating cycle of debt.
For these reasons, it's recommended that you avoid rolling over negative equity into a new auto loan unless you can cover the balance out of pocket. If you can't, you're better off waiting and making payments on your old loan until you either get in an equity situation or have paid off the loan.
The Bottom Line
Trading in a car when you still owe on it isn't a problem when you have equity in it. The dealership will pay off the old loan and either give you the cash or use the rest as a down payment on your new car. When you still owe and have negative equity, however, you're responsible for the difference even if you trade in the car before it's paid off.
Regardless of whether or not you have a vehicle to trade in, Auto Credit Express can help you find a local dealership to get financed. We work with a countrywide network of dealers that are trained in the handling of challenging credit situations. If you have less than perfect credit and need an auto loan, get started by completing our free and easy car loan request form today.