Is It Better to Trade In or Refinance?

Car owners often face a financial decision: trading in their vehicle for a newer model or refinancing their existing auto loan. Both aim to optimize car ownership costs and serve distinct financial purposes. Understanding each option is important for an informed choice.

Understanding Trading In Your Vehicle

Trading in a vehicle involves using its value as a credit toward the purchase of another, typically newer, car. Trade-in value is determined by factors including make, model, mileage, condition, and market demand. Dealerships consult industry valuation tools and conduct physical inspections.

When your vehicle’s trade-in value exceeds its outstanding loan balance, you have “positive equity.” This equity can be applied as a down payment on the new vehicle, reducing the amount financed. For example, if your car is valued at $15,000 and you owe $10,000, the $5,000 positive equity can lower your new loan principal.

Conversely, “negative equity” occurs when the outstanding loan balance exceeds the vehicle’s trade-in value. Dealerships may allow you to roll this deficit into the new car loan, increasing the total financed. For instance, if you owe $18,000 on a car worth $15,000, the $3,000 negative equity could be added to the new car loan, leading to higher monthly payments.

Trading in happens concurrently with securing a new loan. The dealership facilitates both transactions, applying the trade-in value (or rolling over negative equity) directly to the new vehicle’s purchase price, and settling the old loan as part of the new financing agreement.

Understanding Refinancing Your Auto Loan

Refinancing an auto loan means obtaining a new loan to pay off your existing car loan, usually for more favorable terms. Borrowers gather information such as current loan balance, interest rate, remaining loan term, income, employment history, and credit score for the application.

Refinancing lenders include banks, credit unions, and online financial institutions. Benefits sought are a lower interest rate, reducing total interest paid. Borrowers may also aim for a reduced monthly payment by extending the loan term, or a shorter loan term by maintaining or increasing monthly payments.

Refinancing begins with an application to a chosen lender. The lender reviews the application, including a credit check. After review, the lender provides loan offers detailing potential interest rates and terms.

Upon accepting an offer, the borrower signs loan documents. The new lender pays off the old loan, and the borrower begins payments to the new financial institution under revised terms. This process typically takes a few weeks, with payoff and title updates occurring within 30 to 60 days.

Key Considerations for Your Decision

Deciding between trading in or refinancing involves evaluating factors specific to your financial situation and vehicle. Your current auto loan terms, including interest rate and remaining balance, are starting points. Your credit score also plays a role, as an improved score could qualify you for lower interest rates on a new car loan or a refinanced loan.

Your financial goals guide this decision. If your priority is to reduce monthly expenses, a lower monthly payment through refinancing or trading down to a less expensive vehicle might be suitable. If acquiring a newer vehicle with updated features, or addressing changing family needs is the goal, trading in becomes a more direct path.

Vehicle-specific factors are considered. The current condition and reliability of your existing car matter, as frequent repairs can quickly erode financial benefits from keeping it. Assessing your vehicle’s market value helps determine whether you have positive or negative equity, which impacts the financial viability of a trade-in.

Costs for each option require comparison. Refinancing may involve fees, such as application or title transfer fees. When purchasing a new vehicle, costs include sales tax, which in many states is calculated on the purchase price minus any trade-in allowance. Rolling over negative equity into a new loan will increase the principal amount.

If your current vehicle is reliable and meets your needs, but your loan terms are unfavorable, refinancing could be the preferred option, especially if your credit has improved. Conversely, if your car is experiencing frequent mechanical issues, or your personal circumstances necessitate a different type of vehicle, trading in might be a more practical solution.