Trading in a Car with Loan Debt
Owning a car is almost a necessity in the modern world. We use our cars for everything, from visiting friends and picking up groceries to going to work or traveling for vacation. Therefore, it should come as no surprise that many people take out a loan in order to obtain a safe, reliable car that will help them accomplish their daily tasks.
However, cars and car loans can be tricky. Cars are more prone to losing value than other things you might get a loan for, like a house or a business. Moreover, most people trade their old car in to the dealer when they are buying a new car so that they can lower the overall cost they’re going to pay. As a result, many people have begun to worry about what happens if they need to trade their car in while they are still paying off the loan for it.
Understanding Car Loans and Trade-Ins
One of the biggest complications when trading in a car is understanding how any outstanding loans can affect your trade in. There are two possible situations. Your car can be worth more than the balance of your loan, or it can be worth less. If your car’s trade-in value is greater than the balance on your loan, then the dealership will pay your lender the value of the balance and will apply the remainder of the trade-in value to your new purchase. However, when your loan balance is greater than the value of your car things work a bit differently.
Car Trade-In Worth Less than Loan Balance
If you owe more than your car is worth, then your trade in will be a bit more complicated. This situation is referred to as being upside down on your car loan. It is also called having negative equity in your car. All of these terms just mean that you owe more on your car loan than your car is valued at.
The best advice is that you should avoid trading in a car with negative equity unless you have no other option. The reason is that the amount you owe will continue to build up until your car payment becomes unaffordable. For example, if you owe $10k on a car that is valued at $5k, then after your trade-in you’ll still have a $5k balance, but you won’t own the car anymore. Moreover, you’ll probably require a new loan to get your new car. Frequently, the value you still owe will be added to your new car loan, increasing its overall cost. Additionally, depending on your financial situation you might not be able to get as good of an interest rate on your new loan. This is even more likely considering the fact that your loan will be influenced by your lack of trade-in value.
People who buy brand-new cars place themselves at extra risk in this process. New cars depreciate in value very quickly. Therefore, a car that is brand-new will lose value much faster than you can pay off the loan. You can see how this can quickly create a cycle that results in escalating car payments as the previous loan balance is rolled into your new car loan every time you buy a new car.
Options for Upside-down Car Loans
There are a few things you can do to help your situation if you find you have negative equity for your car. The first option is to continue to use the car you have until you’ve paid off enough of the loan to gain positive equity in the car. That is, continue to use your car until you’ve paid enough of the loan that the car value is greater than the remaining balance of the loan.
The next option is to use your savings to pay off your current loan. This strategy can help you gain positive equity in your car quickly. However, using your savings might mean that you don’t have any money for a down payment on a new car. This can dramatically raise the cost of the car. Moreover, banks are less likely to approve car loans for people with small or no down-payments. Therefore, you’ll have to carefully consider your options and specific financial situation when you’re thinking about using this strategy to get positive equity from your car.
Another option that you might consider is refinancing your current car loan. Interest rates change all the time. If the government has lowered overall interest rates or if your financial situation and credit score have improved to the point that you qualify for a lower interest rate than refinancing might be the best option for you.
When you refinance your car loan you are essentially taking out another loan for the value of your current balance and paying off your old car loan. However, the new car loan will have lower interest rates, which means that the overall cost of the loan will be less. This can reduce your monthly payments and also get you closer to establishing positive equity in your car.
Finally, if you’re upside-down on your car loan but need a new car you can try selling your vehicle privately. Private sales usually bring more money for a car than a trade-in. The private individual is going to use your car, rather than resell it for a profit. Therefore, that person will be willing to pay more for the car than a dealership would. You can then use the money from the private sale to pay off your existing car loan and obtain a new car without emptying your savings.
It's always better to continue to use your car if you have negative equity in it. However, there are times when you absolutely need a new car while your old car isn’t worth as much as you owe on it. Use these strategies to handle that situation without placing yourself further into a never-ending cycle of car loan debt. After all, you need your car to live your life, but your car loan should not control your life.
Carl has years of experience helping people tackle debt. As a Senior Financial Advisor, he knows the ins and outs of debt consolidation and debt management. He holds a Masters Degree in Finance and according to him, not all debt problems are the same and that’s why it’s important to take a look at the different options available for your situation.