If you're still making payments on a car, your lender has a lien on the vehicle's title. This means that if you were to stop making payments, the lender has a right to repossess the car.
Trading in a car with a lien on the title is possible, but that lien has to be removed before the vehicle can legally be sold to a dealership. And, usually, if a car buying customer brings a car to trade in that they still owe money on, they're in one of two situations.
Trading in a Car with Equity
In a best-case scenario, the buyer who wants to trade in a vehicle that they're making payments on has equity in the vehicle. This means that the car's current trade-in value is higher than their loan balance. In this situation, the trade-in process is fairly simple.
For example, let's say that a buyer wants to purchase a $25,000 vehicle. They also want to trade in a car that's valued at $8,000. This buyer still owes $5,000 on their current loan, but that's OK. The dealer simply pays off the loan balance and applies the remaining $3,000 toward the purchase price of the new car.
So, if you know that you have equity in the vehicle that you want to trade in, you should have nothing to worry about. If you're unsure about the equity you might have, you should first call your current lender and ask what your loan payoff amount is. Then, you can consult one of the main vehicle valuation guides online, such as NADAguides, in order to get an estimate of your car's current trade-in value.
On the other hand, if the outstanding balance on your loan is more than what your vehicle is worth, you have negative equity. In this situation, trading a car in on the purchase of another vehicle gets more complicated.
Trading in a Car with Negative Equity
Having negative equity in a vehicle (or being "upside down") makes it more difficult to trade that car in. This is because the difference between your vehicle's value and the loan balance isn't going to just disappear.
Here are two examples of how trading in a car with negative equity is possible.
Buyer A wants to purchase a $30,000 vehicle. They have a car that they want to trade in that the dealer has appraised and valued at $10,000. However, they still owe $12,000 on the loan. Luckily, Buyer A is willing and able to pay the $2,000 difference out of pocket. The lien is removed and Buyer A only has to worry about making payments on the new car.
Buyer B wants to purchase a $40,000 vehicle. This buyer has a vehicle to trade in that's valued at $6,000. Unfortunately, Buyer B owes $11,000 on the loan. They knew that they were upside down before going to the dealership. They chose this particular dealer because of their advertised claim. The dealership said that they would "pay off your loan, no matter how much you owe."
And, yes, this dealer does pay off Buyer B's loan balance in order to remove the lien from the vehicle. But the $5,000 difference between the car's trade-in value and the loan pay off amount is rolled over into Buyer B's new loan.
So, Buyer B's $40,000 vehicle now has a $45,000 loan. Buyer B will have to pay $5,000, plus interest charges, on a car that they no longer own. And unless Buyer B is able to provide a very good down payment, they'll immediately be even further upside down in the new car.
Why Rolling Over a Loan Balance Can Be Risky
Even if a dealer is able to roll a balance from an old loan into a new one, this may not be the best option. Doing this means that you have to take out a bigger loan and pay more in interest charges.
So, if you're thinking about trading in a car that you're upside down in, you may want to wait. It'll be better for your wallet in the long run if you have equity in your current vehicle.
Of course, you can always try to sell the car yourself. You may be able to get more than you would when trading in your vehicle at a dealership. This may allow you to eliminate or further reduce any negative equity.
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