Do Dealerships Pay Off Your Trade No Matter What You Owe?

When considering a new vehicle, many owners discover they owe more on their current car loan than the vehicle is worth. This financial situation, known as negative equity, can create challenges when attempting to trade in a car. This article explains negative equity and outlines how dealerships facilitate trade-ins.

The Concept of Negative Equity in Vehicle Financing

Negative equity arises when the outstanding balance on a vehicle loan exceeds the car’s current market value. For instance, if a car owner owes $20,000 on a loan, but the vehicle’s market value is only $15,000, there is $5,000 in negative equity.

New vehicles experience rapid depreciation, often losing a significant portion of their value within the first year of ownership. This rapid decline can outpace the rate at which the loan principal is paid down, especially with long loan terms. High interest rates can also lead to a larger portion of early payments going toward interest rather than principal reduction, slowing equity buildup.

A small or non-existent down payment increases the likelihood of negative equity, as it means a larger initial loan amount. If previous negative equity was rolled into the current loan, it can perpetuate a cycle where the owner starts a new loan already owing more than the vehicle is worth. High mileage can further accelerate depreciation, reducing its market value.

How Dealerships Structure Trade-ins with Negative Equity

When a vehicle owner with negative equity trades in their car, dealerships incorporate the outstanding balance into the financing of the new vehicle. This process is called “rolling over” the negative equity. Dealerships do not simply pay off the difference; instead, the existing loan on the trade-in is settled by the new lender, and the deficit is added to the principal of the new car loan.

For example, if a customer has $3,000 in negative equity on their trade-in and is purchasing a new vehicle for $25,000, the new loan amount would effectively become $28,000. This allows the customer to acquire a new vehicle without immediately paying the negative equity out of pocket. However, it means the new loan’s total amount is higher, leading to increased monthly payments and a greater total interest paid over the life of the loan.

Rolling over negative equity can prolong the period a buyer remains “underwater” on their new vehicle. Lenders may allow financing up to a certain loan-to-value (LTV) ratio to accommodate the rolled-over negative equity. This enables dealerships to complete sales for customers who might otherwise be unable to trade in their vehicles.

Steps to Take Before Visiting Dealerships

Before visiting any dealership, gather information about your current vehicle loan. Obtain the exact payoff amount from your current lender, as this figure is typically higher than the balance shown on a monthly statement due to accrued interest and potential fees. You will need your loan account number and possibly your Vehicle Identification Number (VIN) to access this information.

Research the current market value of your trade-in vehicle using reputable online valuation tools like Kelley Blue Book (KBB) or Edmunds. Comparing this estimated value to your loan payoff amount will reveal the precise extent of your negative equity.

Checking your credit score is another preparatory step. Your credit score significantly influences the interest rates and terms you may qualify for on a new car loan. A higher credit score typically leads to lower Annual Percentage Rates (APRs). Finally, assess your financial budget to determine what new monthly payment you can realistically afford, considering that rolling over negative equity will increase the principal amount of your new loan.

Locating Dealerships and Completing the Transaction

Identify dealerships that can accommodate a trade-in with negative equity. Most dealerships handle these transactions, but it is beneficial to inquire about their policies before an in-person visit. Some dealerships might advertise “trade-in assistance” or “negative equity solutions,” which can be a good starting point.

When engaging with a dealership, discuss your trade-in and the presence of negative equity early in the negotiation process. Focus the discussion on the total cost of the new vehicle, including any rolled-over negative equity, rather than solely on the monthly payment. Be prepared to review all figures carefully, including the trade-in allowance, the new vehicle price, and the final loan amount that incorporates the negative equity.

Upon reaching an agreement, sign a new loan agreement that reflects the combined principal of the new vehicle and the rolled-over negative equity. You will transfer the title of your old vehicle to the dealership, or the new lender will pay off your old loan directly. Ensure you receive confirmation that your original loan has been fully paid off after the transaction is complete. Be aware of all associated fees and ensure they are clearly itemized in the final contract.