Is a Loan Canceled with Trade In?
If you’re still making loan payments on a car you’re planning to trade in, be aware that the loan won’t just disappear. The remaining balance has to be paid off. That may not be an issue if the amount you owe is less than the trade-in value of the car, but it can become a problem if you owe more than the car is worth.
How Auto Financing Works
Traditionally, when you take out an auto loan, the car itself serves as collateral for the loan. That’s why, if you were to stop making payments on the loan, the lender would repossess the car. The loan gives the lender a “lien,” or claim, on the title. You can’t sell a car that has a lien on it — and “trading in” a car is really just selling it to the dealer. So you have to get the lien removed, which you do by paying off the loan.
How Trading In A Car Works
When the amount you owe on the car is less than the trade-in value, the process is pretty straightforward. Say you still owe $5,000 on a car, and a dealer offers you $6,000 for it as a trade-in. The dealer pays off the $5,000 loan for you, which releases the lien. Then, you transfer ownership of the car to the dealer. There’s $1,000 left over, which the dealer knocks off the price of your new car. This all takes place in a flurry of paperwork when you sit down with the dealer’s finance people.
What Does it Mean if Your Car Loan is Upside Down?
Problems arise when you’re “upside down” on the car — that is, when the outstanding balance on the loan is more than the dealer is offering in trade-in value. This situation has become quite common as more people buy cars with low (or no) down payments. New cars lose value quickly. In fact, in no-down-payment situations, buyers can be upside down literally the minute they drive off the lot, since the car is now no longer “new”.
What Does “Rolling Over” A Loan Mean?
When you’re upside down, dealers may promise to “pay off” your old loan regardless of how much you owe. The reality, however, is that you’re the one who winds up paying off the old loan, because it usually just becomes part of your next loan. Say you owe $10,000 on a car, and the dealer offers $6,000 in trade-in. The dealer takes the remaining $4,000 and “rolls it over” into the loan on your new car. If you were buying a $30,000 car, then, you’d sign for a $34,000 loan. Buyers accept these arrangements all the time, but understand that it means you’ll be paying for a car you’re no longer driving — and the extra amount on the loan increases the likelihood that you’ll be upside down on your new car, too.
The simplest way to avoid a rollover situation on a trade-in is to pay off the balance yourself if you have the cash. Failing that, keep the car and continue making payments until you’re not upside down anymore. If you’re trading in because you’re having trouble making the payments, see if you can refinance your auto loan — extending the term in exchange for lower payments. Alternatively, you can keep shopping around for a dealer that’s offering incentives large enough to cover the outstanding balance on your existing loan.
About the Author
Cam Merritt has been a professional writer and editor since 1992, specializing in articles about personal finance and law. He has contributed to USA Today and the Better Homes and Gardens family of magazines and websites. Merritt has a Bachelor of Arts in journalism from Drake University.
This article is provided for general guidance and information. It is not intended as, nor should it be construed to be, legal, financial or other professional advice. Please consult with your attorney or financial advisor to discuss any legal or financial issues involved with credit decisions.
Published by permission from ConsumerInfo.com, Inc., an Experian company. © 2014 ConsumerInfo.com, Inc. All rights reserved.