Trading in a Car with a Loan

It may be possible to trade in a car even when you owe an outstanding loan balance. But it’s important to prepare in advance before trading in a car that you’re still paying off.

If you try trading in a car with a loan balance and make mistakes along the way, you risk getting less than fair market value for your vehicle. Here’s what you need to know about how to trade in a car with a loan and how to protect your finances and credit during the transaction.

Can you trade in a car with an outstanding loan balance?

Everyone’s vehicle trade-in scenario is a little different. The auto dealership and new lender you’re working with, the car you want to trade in, your credit score, and the amount you owe your current lender can all play a role in your ability to trade in your existing vehicle and buy a new one.

There’s another important factor that can influence your odds of trading in a car with a loan balance—the equity you have in your current vehicle. Positive equity could work in your favor during the trade-in process while negative equity might be (and perhaps should be) a deal breaker.

Positive equity

When your car is worth more than the amount you owe to the lender, you have positive equity in the vehicle. For example, if you own a car that’s worth $15,000 but you only owe the lender a balance of $10,000 on your car loan, you have $5,000 in positive equity on your vehicle.

Positive equity can work in your favor when you trade in a car and purchase a new one. The dealer may apply the equity from your current vehicle toward the purchase price of the next car you wish to buy, bringing down the overall amount you need to finance like a down payment would do. However, it’s important to know the value of your current car before you visit a dealership to make sure you get a good offer for your trade-in.

Negative equity

When the payoff amount on your auto loan is higher than the value of your car, you have negative equity in your vehicle. For example, if you own a car that’s worth $10,000 but you owe your lender $15,000 on your auto loan, that’s negative equity. Sometimes people may refer to this unfortunate financial situation as being “underwater” or “upside down” in your auto loan.

Negative equity can be a serious problem when trading in a car with a loan. The Consumer Financial Protection Bureau (CFPB) warns that if you owe a lender more than your car is worth and transfer that negative balance to a new car loan, the cost of your new financing could be much higher. You’ll immediately be upside down in your new auto loan, perhaps to a worse degree than you were before the trade-in.^[1]

If you’re in the unfortunate position of having negative equity in your car, you might want to review some alternatives to trading in a financed car in this situation. If possible, consider the following options instead.

• Postpone the transaction: Wait until you pay off your current car loan, or at least until you pay down your loan balance enough to resolve the negative equity issue, to trade in your vehicle.

• Pay down your loan balance: If you have extra money available, it may be helpful to pay down (or pay off) the negative equity in your original auto loan before your trade-in. This approach could help you start your new loan off on better terms.

How to protect yourself when trading in a car with negative equity

If you believe that rolling over negative equity from a trade-in to a new car loan is your only option, there are still steps you can take to try to minimize potential negative consequences. The following tips may help.

• Shop around for the best interest rates on your new car loan.
• Make a sizable down payment (if you can afford to do so).
• Consider downsizing to a more affordable vehicle to reduce the size of your new loan.
• Work to improve your credit in an effort to qualify for more attractive car loan offers.
• Confirm that your original loan has a zero balance after transferring the balance to a new lender.

How trading in a financed car works

Trading in a financed car isn’t uncommon. But it’s normal to have questions about how the process works.

Below are four general steps you can take to set yourself up for success if you decide to trade in a financed vehicle and purchase a new one.

1. Find out how much you still owe

Before you start shopping for a new vehicle, it’s important to know how much you owe on the car you’re trading in. You can learn this information by contacting your current lender and requesting the “payoff amount” on your current auto loan. (Note: The payoff amount may be slightly different than the balance listed on your loan statement or online account dashboard.)

2. Research your vehicle’s trade-in value

Next, it’s important to look up the trade-in value of your car based on its make, model, age, condition, mileage, and other details. Your location can also impact how much an auto dealer will offer you when you trade in your vehicle.

Online pricing guides like Edmunds and Kelley Blue Book (KBB) can be helpful resources during this research process. When you know the approximate market value for your vehicle in advance, it can put you in a better position to recognize fair and unfair trade-in offers.

3. Gather documentation and other key items

Before you visit any auto dealers, it’s wise to prepare some basic documentation in advance. (The same rule applies if you plan to seek outside financing from a separate bank or credit union.)

Some of the documents and other items you may need to provide when you apply to trade in a car with a loan include:

• Loan payoff amount
• Insurance information
• Registration
• Driver’s license
• Proof of income and employment
• Proof of residency
• Maintenance records (could increase trade-in value)
• Car keys

Note: Until you pay off your loan, the original lender (aka lien holder) will retain the title to your vehicle.

4. Shop around and negotiate

Once you gather the information and documentation above, you may be ready to start shopping around and comparing trade-in offers from multiple dealerships. Used-car dealers and marketplaces like CarMax, Vroom, Carvana, and others may provide you with trade-in quotes too.

You may also want to keep the following details in mind as you begin gathering trade-in offers.

• It’s fine to trade-in your vehicle and buy a new car from separate auto dealers.
• If you trade in your vehicle and purchase from the same auto dealer, ask the salesperson to keep the negotiations for each transaction separate to protect yourself from any potential manipulation of figures.
• You may find a better deal by trying to get preapproved for a car loan before you visit an auto dealership.
• Selling your car to a private party tends to be more work, but might also result in a bigger profit from the sale of your vehicle.
• You may be able to negotiate with an auto dealer and get them to increase their initial trade-in offer or reduce the purchase price of your new vehicle.

Selling a financed car privately

Selling a car with a loan to a private party could be more lucrative, but also more complicated. If you want to sell a financed car yourself, you can still start the process much as you approach trading in a car with a loan.

• Step one: Find out how much you owe.
• Step two: Use a tool like Kelly Blue Book or Edmunds to research the private party value of your vehicle.

Once you gather basic information about your vehicle’s payoff amount and market value, it’s time to contact your lender to find out its requirements to complete a private-party sale. Keep in mind that you won’t hold the title to your vehicle until the original loan has a zero balance.

If you have good credit, you might consider taking out a personal loan to pay off the auto loan, get the title in your name, and then sell the vehicle to a private party. This approach could make the resell process smoother. Otherwise, you might have to try negotiating an arrangement where the buyer pays the auto lender and the lender mails the title directly to the buyer after loan payoff. (These situations require trust on the part of the buyer, and typically only work if you have a personal relationship.)

Pros and cons of trading in a car with an outstanding loan

As with any type of financing, there are potential pros and cons to trading in a car with an outstanding loan balance.

Benefits of trading in a car with an outstanding loan

• Budget reset: If your household budget is overextended, trading in a financed car gives you a chance to try to secure a lower interest rate or a cheaper vehicle to reduce your monthly payments.
• Possible tax advantages: In many states, you’ll only need to pay taxes on the difference between the price of your trade-in and the new vehicle you’re purchasing. ^[2]
• Positive equity: If your car is worth more than you owe your lender, you could use that positive equity to your advantage on a new vehicle purchase.

Potential problems with trading in a financed car

• Negative equity: If you opt to trade in a car with negative equity, you could face higher interest rates (due to the increased risk to the lender), a larger loan amount, and higher monthly payments.
• Lower price: An auto dealer is likely to offer you a lower trade-in price for your vehicle than you might receive if you sold your car yourself to a private party.

Does trading in a financed car hurt your credit?

A well-managed car loan could help you build good credit over time. But as with any new credit obligation, trading in a vehicle with an outstanding loan has the ability to influence your credit score in positive and negative ways.

Below are three ways that trading in a car with a loan could impact your credit.

• Payment history: The biggest impact a new car loan will have on your credit score comes down to how you manage your account. If you consistently pay your bill on time, that positive payment history could be beneficial. Payment history affects 35% of your FICO Score. Therefore, on-time payments are an essential part of earning and keeping a good credit score.^[3]
• Length of credit history: When you trade in a financed car for a new one, a new loan may show up on your three credit reports. If this happens, the average age of the accounts on your credit reports could go down. This change can impact your length of credit history—worth 15% of your FICO Score. Newer accounts could drive your credit score down in this category, at least until they grow older and you prove you can manage them in a responsible manner.^[4]
• Credit inquiries: When you apply for a new car loan, the lender will check a copy of your credit report from at least one credit bureau—Equifax, TransUnion, or Experian. This credit inquiry might damage your credit score, though usually only slightly. Note: FICO Scores count multiple rate-shopping credit inquiries (auto, mortgage, and student loan) in a 14-day window as a single credit inquiry. Newer FICO Scores extend this time span to 45 days. So, you can shop around for the best deal on an auto loan without fear of hurting your FICO Score.^[5]

Details to consider before trading in a financed car

It’s wise to consider the following details before you drive down to the dealership and start chatting with a salesperson about trading in a car with a loan.

• Trade-in value: Knowing the trade-in value of your vehicle in advance from a reliable third-party source is essential. Otherwise, you risk getting taken advantage of and accepting a lowball offer from an auto dealer.
• Amount you owe: You also want to know your outstanding loan balance before you visit a car dealership to start shopping for a new car. This information, along with the trade-in value of your car, can help you determine if you have positive or negative equity in your vehicle.
• How much you want to spend on a new vehicle: Your budget and finances are key factors that determine how much you should spend on a new car (and if you’ve saved enough in advance). It’s important to choose a new vehicle with a price that translates into affordable monthly payments.
• Loan options: The purchase price of your vehicle isn’t the only factor that influences your monthly payment amount. The car loan you choose—especially its interest rate—will also impact the affordability of your monthly payment and the overall interest charges you pay to a lender as well. It’s important to shop around and select the best car loan for your situation. And if you can work to improve your credit prior to your new loan application, even better.

Bottom line

There’s no question that having a reliable vehicle to get to work or transport your family is important. Yet you still want to make sure that trading in a car with a loan will put you in a better financial position, not a worse one before you move forward.

Sources

1. Consumerfinance.gov. “What happens if I still owe money on the vehicle I want to trade-in?” https://www.consumerfinance.gov/ask-cfpb/what-happens-if-i-still-owe-money-on-the-vehicle-i-want-to-trade-in-en-2045/
2. Capitalone.com. “Understanding the Tax on Car Purchases: What You Need to Know.” https://www.capitalone.com/cars/learn/managing-your-money-wisely/understanding-the-tax-on-car-purchases-what-you-need-to-know/1246
3. myFICO.com. “What’s in my FICO® Scores?” https://www.myfico.com/credit-education/whats-in-your-credit-score
4. myFICO.com. “What is the Length of Your Credit History?” https://www.myfico.com/credit-education/credit-scores/length-of-credit-history
5. myFICO.com. “Credit Checks: What are credit inquiries and how do they affect your FICO® Score?” https://www.myfico.com/credit-education/credit-reports/credit-checks-and-inquiries

About the author

Michelle Lambright Black is a nationally recognized credit expert with two decades of experience. She is the founder of CreditWriter.com, an online credit education resource and community that helps busy moms learn how to build good credit and a strong financial plan that they can leverage to their advantage. Michelle's work has been published thousands of times by FICO, Experian, Forbes, Bankrate, MarketWatch, Parents, U.S. News & World Report, and many other outlets. You can connect with Michelle on Twitter (@MichelleLBlack) and Instagram (@CreditWriter).

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