Can You Trade In a Car If Behind on Payments?

It is a common scenario for car owners to find themselves falling behind on vehicle payments, leading to questions about potential solutions like trading in the car. While trading in a vehicle with outstanding debt is possible, it involves various financial considerations and complexities. Understanding these factors is important for making informed decisions.

Understanding Negative Equity

Negative equity, often referred to as being “upside down” or “underwater” on a car loan, occurs when the outstanding loan balance on a vehicle is greater than its current market value. For instance, if you owe $20,000 on your car but it is only worth $15,000, you have $5,000 in negative equity.

One primary cause of negative equity is rapid vehicle depreciation. New cars can lose a significant portion of their value, sometimes as much as 20%, during their first year of ownership. This swift decline means the car’s worth can drop faster than the loan balance decreases, especially in the initial stages of a loan.

Longer loan terms also contribute to negative equity, as they extend the period over which the loan balance is paid down, slowing equity buildup. Making a low or no down payment also results in financing a larger portion of the car’s value, which can quickly lead to an upside-down loan as depreciation begins immediately. Being behind on payments often indicates existing negative equity, as the loan balance remains stagnant or increases while the car’s value declines.

Trading In a Vehicle with Outstanding Debt

Trading in a vehicle when you are behind on payments and have negative equity is a common inquiry. Dealerships are equipped to handle such situations, but the process has specific financial implications. The dealership will assess your current vehicle’s trade-in value, which is often lower than what you might achieve through a private sale.

One common method dealerships use is “rolling over” the negative equity. This means the outstanding balance from your old car loan is added to the new car loan, increasing the total amount you finance for the new vehicle. For example, if you have $3,000 in negative equity and the new car costs $25,000, your new loan could be for $28,000 plus interest. This practice can lead to higher monthly payments and increased interest charges over the loan’s term.

Alternatively, you could pay off the negative equity out-of-pocket at the time of the trade-in. This involves paying the difference between your outstanding loan balance and the dealership’s trade-in offer. For instance, if you owe $10,000 and the trade-in offer is $9,000, you would pay $1,000 to cover the negative equity. This approach prevents the negative equity from being added to your new loan.

Some dealerships might advertise incentives that appear to cover negative equity. However, scrutinize these offers, as they often involve passing the cost on to you in other ways, such as higher prices for the new vehicle or less favorable loan terms. While trading in a financed car is possible, it is often more financially beneficial to wait until you have positive equity.

Exploring Other Solutions for Vehicle Debt

When facing challenges with car payments, especially with negative equity, exploring alternatives to a trade-in can provide more favorable outcomes.

Refinancing Your Loan

Refinancing the existing loan could potentially lower your monthly payments or interest rate. However, refinancing may be difficult to secure if you have already missed payments or have significant negative equity, as lenders may view it as a higher risk.

Selling Privately

Selling the vehicle privately often yields a higher price than a dealership trade-in. If you sell privately, you would use the proceeds to pay off your outstanding loan. If the sale price is less than what you owe, you are responsible for paying the difference to your lender to release the lien and transfer the title to the buyer.

Contacting Your Lender

Contacting your current lender proactively can open up solutions. Lenders may be willing to work with you to avoid repossession, potentially offering options such as payment deferrals or loan modifications to adjust terms. These arrangements can provide temporary relief.

Voluntary Repossession

Voluntary repossession, also known as voluntary surrender, is a last resort. This involves returning the car to the lender when you can no longer afford the payments. It still results in a negative mark on your credit report, and you may still owe a “deficiency balance” if the car sells for less than the loan amount, plus any associated fees.

Financial Implications of Unpaid Vehicle Loans

Failing to address unpaid vehicle loans can lead to severe financial consequences that extend beyond the car itself.

Credit Score Impact

One significant impact is on your credit score. Late payments, especially those reported 30 days or more past due, can substantially lower your credit score and remain on your credit report for up to seven years. This negative mark can affect your ability to obtain credit in the future.

Vehicle Repossession

If payments continue to be missed, the lender has the right to repossess the vehicle. Repossession can occur without prior notice in many states once a loan is in default. The immediate aftermath of repossession includes losing access to your transportation and incurring repossession fees.

Deficiency Judgments

Even after repossession and the subsequent sale of the vehicle by the lender, you might still owe money. This remaining balance is known as a deficiency judgment. Lenders sell repossessed vehicles, and if the sale price does not cover the full outstanding loan balance plus repossession and sale costs, you are legally responsible for the difference. This deficiency can be pursued through collections or legal action.

A damaged credit history resulting from late payments, repossessions, or deficiency judgments can hinder your ability to secure future loans, including mortgages or other vehicle financing, often leading to higher interest rates or outright denials.