If you’re ready to purchase a new car, one of the first things you need to figure out is what to do with your current vehicle. There are two main options. You can either sell it to a private party or trade it in at a dealership. There are pros and cons to both, but trading it in at a dealership is more convenient, which is why so many people choose this option.
Trading in your vehicle involves selling it to a dealership in exchange for cash or credit toward the purchase of a new car. Once you trade in your vehicle, the dealership can resell it to one of their customers at a higher price.
If you don’t owe anything on your vehicle, trading it in at a dealership is simple and straightforward. However, trading in a car with a loan is a bit more complicated. What happens to your loan? How much will you earn from the trade-in? Here’s everything you need to know before trading in a car with a loan:
How to Calculate Your Equity
If you’re trading in a car you still owe money on, the first thing you need to do is determine whether you have positive or negative equity in your vehicle.
The term “equity” refers to the portion of the vehicle that you legally own. To calculate your equity, subtract the remaining balance on your loan from your vehicle’s resale value. If the difference between these two numbers is positive, you have positive equity. If the difference between these two numbers is negative, you have negative equity, which means you are underwater on your loan.
For example, if your vehicle is worth $15,000 and you still owe $5,000 on it, you have $10,000 in equity ($15,000-$5,000=$10,000). Because $10,000 is a positive number, this means you have positive equity in your vehicle.
On the other hand, if your vehicle is worth $8,000 and you still owe $10,000 on it, you have -$2,000 in equity ($8,000-$10,000=-$2,000). Because -$2,000 is a negative number, this means you have negative equity in your vehicle.
Take the time to calculate your equity. Knowing whether you have positive or negative equity will impact how you should move forward with the trade-in process.
How to Trade In A Car With Positive Equity
If you have positive equity, you can trade in your vehicle and apply your equity toward the purchase of a new car.
Consider the same from above. Your car’s resale value is $15,000 and you owe $5,000 on it, which means you have $10,000 of positive equity. Even though your car’s resale value is $15,000, its trade-in value will be lower. The dealership may offer you $11,000 for it, for example.
If you accept this offer, the dealership will use $5,000 of your trade-in money to pay off the remaining balance on your loan. The remaining $6,000 is your positive equity in your vehicle, so you can apply it toward the purchase of a new vehicle. If you purchase a vehicle for $20,000, for example, you will only need to borrow $14,000 from your lender ($20,000-$6,000=$14,000).
You can also make a down payment on your new car to lower the balance even further. For example, you can make a down payment of $5,000 in addition to the $6,000 of positive equity you are applying to the purchase of a new car. This would reduce the amount you owe on the vehicle to $9,000 ($20,000-$6,000-$5,000=$9,000).
How to Trade In A Car With Negative Equity
If you owe more on your car than it is worth, you have negative equity in your vehicle. In this situation, it’s best to hold off on trading in your car until you have positive equity in your vehicle or your loan has been paid off completely. However, if you need to trade in your vehicle right away, it’s important to know how it works when you have negative equity.
You have two options when it comes to trading in a car with negative equity. You can either:
- Pay the Difference
- Roll the Negative Equity Into A New Loan
Pay the Difference
The first option is paying the difference between the trade-in value and the remaining balance on your loan.
For example, say your vehicle’s trade-in value is $8,000 and you still owe $10,000 on it, so you have $2,000 of negative equity in your vehicle. If you trade it in, the dealership will put the $8,000 toward your auto loan balance. This means your remaining balance on your auto loan will be $2,000. You are responsible for paying the dealer this $2,000 difference.
You will not have any equity to apply to the purchase of a new vehicle. If you plan on buying a new vehicle, you will need to pay in cash or finance the purchase.
Roll the Negative Equity Into A New Loan
Your second option is rolling the negative equity into a new car loan. In other words, adding the balance on your current auto loan to the balance on your new auto loan.
Consider the same example from above. You have $2,000 in negative equity and you plan on taking out a new $20,000 auto loan to purchase a new car. If you choose to roll up your negative equity, the dealer will add the $2,000 to your $20,000 balance, so you will now need to pay off $22,000 in debt.
If you don’t have the cash to pay the difference, this is your only option. However, this option can cost you. Because the negative equity is being rolled into a new loan, you are required to pay interest on it. Furthermore, rolling up your negative equity may immediately make you underwater on your new loan. For these reasons, it’s best to avoid this option unless it is the only one available.
Tips for Trading In A Car With a Loan
Follow these tips when trading in a car with a loan regardless of whether you have positive or negative equity:
- Get multiple trade-in offers. Request trade-in offers from multiple dealerships so you can ensure you are getting as much money as possible for your vehicle.
- Don’t be afraid to negotiate. Everything is negotiable at a car dealership, including trade-in offers. If you aren’t satisfied with the first offer, feel free to make a counteroffer. The worst the dealer can say is “no.”
- Confirm that your loan has been paid off. If you trade in a car with a loan, the dealership is responsible for paying off your car loan. Make sure the dealership did what they were supposed to by checking your loan balance several weeks after the trade-in took place.
Now you should have a better understanding of how to trade in a car if you still owe money on it. Keep this information in mind so you know what to do when the time comes to trade in your vehicle for a new one.