What Happens to Your Loan When You Trade In a Car?
A Trade-In With a Loan
Begin with this example: You drive a car with an outstanding loan balance of $6,000. You want to trade in the car on a new one. The dealer will give you $4,000 for your trade in. That means you still owe $2,000. If you buy from that dealer, and the dealer is willing to do it, he will assume the outstanding loan and pay it. But he will also add that amount to the loan for your new car. That is called negative equity because you already owe more than your new car is worth.
The Impact on You
The first impact when you trade in a car with a loan and have a negative equity situation is you will face a higher interest rate. All lending rates are based on risk, and if you are borrowing more than your vehicle is worth. If you should default, recovering the vehicle from you doesn't clear the loan with the lender. The second impact is you will have higher payments than you would have had. When you trade in a car with a loan balance, it costs you.
Get the Most You Can for Your Car
You can remove your burden by being well prepared and knowledgeable. The most important thing to know is the value of your current car. There are numerous sources - beginning with simply looking at what similar cars are going for around town - to find out current used car prices. The dealer will start with a low offer, and if you don't know better, you simply are increasing the amount of negative equity in your new car loan.
Look for Incentives
Perhaps the easiest way to lower the negative equity created when you trade in a car with a loan is to get the dealer to apply incentives to your loan. If there is a large cash-back offer, it might wipe out your loan balance. It would be better to have a larger new car loan without the negative equity than to lower the new car price with an incentive and roll your old loan on top of it.
You Are Still Responsible
Even if the dealer takes over your loan when you trade in the car, you are still responsible for the payments. The dealer will collect the monthly payments from your new car loan and apply them to the old car loan. But you must make sure that your money is indeed applied to your loan. You could end up with late pays or a default on your credit report and not even know it. You need to keep close tabs every month on monthly payments and get involved when you see that a payment is not posted within three days of the due date.