Trading in a car you haven't paid off yet is perfectly possible. And you won't be alone, either. In a good year, the automotive industry sells 17 million new vehicles and, according to Statista, 85 percent of those new vehicles are financed. Throw in the fact that, according to a survey by Lending Tree, the average car loan term is almost six years, but that owners typically keep their cars for a little less than six years, and it stands to reason that a whole lot of people are trading in vehicles for which the loan is still outstanding.
What's important, then, is not if you can trade in a car that isn't paid off yet, but how to do it. Which is precisely where this guide comes in.
How to Trade In a Car That Isn't Paid Off
- What is the Process of Trading In a Car?
- The Loan Term
- The Payoff Amount
- What are Positive Equity and Negative Equity?
- The Tax Benefit of Trading In
- Don’t Forget the Paperwork
- Common Questions About Trading in a Car
- CarGurus Instant Cash Offer
What is the Process of Trading In a Car?
Let's start at the beginning, and consider the actual process of trading in a car. Good news is, it's simple–in fact, it's long been one of the greatest services that an automotive dealership provides.
Most dealerships will ask you to bring the vehicle in for a visual inspection before offering a trade-in value. However, some dealership are willing to provide a trade-in estimate via the phone or over email.
In the best case, you show up with your trade-in, make a deal on a new car, and drive out the same day. Modern auto dealerships are so good at this process that they can present the entire deal to you while you’re waiting in the customer lounge for an oil change. You click a few boxes on a tablet and you’re out the door with a brand-new vehicle.
From the dealer's side, they'll need to determine what they’re willing to offer you for a trade-in on your current car, as well as consider the price for which they’ll sell the new car. Chances are that you’re going to be presented with a monthly loan figure rather than the trade offer and the cost of the new car.
The Loan Term
If you’re currently paying $450/month for your financed car, and the loan amount for a new car is $425/month, it’s a no-brainer, right? You’re saving $25 a month to drive a new car!
Not so fast. What you’re missing here is the term of the loan. Say you’re paying $450/month for your current vehicle, but your payoff is $10,000, and your trade is worth $25,000. The deal for the new car is $47,000, less the $15,000 in equity. The equity acts like a down payment on the new loan balance of $32,000, financed at (for example) an interest rate of 3.11% for 84 months.
You’re “saving” $25/month to make car payments for the next 84 months. If you examine all the numbers in the trade-in, that monthly savings might not be a great deal. It’s always in your best financial interest to take the time to understand the multiple moving parts of a deal before you commit to a new car.
The Payoff Amount
As part of the trade-in process, it's critical to determine what kind of equity you might have in your car, truck or SUV, which involves finding out the payoff amount.
The payoff amount is what you owe the lending institution. You might be surprised to learn that a lot of people think that what they owe is simply the monthly payment multiplied by the number of payments left in the entire term of the loan. That figure is almost guaranteed to be way off.
The payoff amount actually changes monthly and might also include an early repayment charge. It’s important to find out the payoff amount when you first start looking for your next car, and then again the day that you decide to trade it.
What are Positive Equity and Negative Equity?
The payoff amount on the day you come to trade in will determine if you have positive equity or negative equity in your vehicle.
Positive equity occurs when your vehicle is worth more than you owe the lender. For example, if you owe $10,000 on your vehicle, but your vehicle is worth $22,000, you have $12,000 in positive equity.
Negative equity is when your vehicle is worth less than you owe the lender. For example, if you owe $10,000 and your vehicle is worth $8,500, you have $1,500 in negative equity.
Negative equity is also referred to being “upside down” in your car loan. It's not great to be upside down, but it's fairly common. Sometimes a new car loan on a better vehicle where you're rolling over the negative equity from your old car can make some financial sense. Say, for example, that your old car is unreliable and you're spending tons of money on repairs every month. Rolling over negative equity from your old loan can be a financial advantage in this case.
The Tax Benefit of Trading In
It's also important to understand the tax benefit of a trade. In a handful of states—Oregon and New Hampshire, for instance—there’s no sales tax, so there’s no real tax advantage to trading. And in seven others—California, Hawaii, Kentucky, Maryland, Michigan, Montana and Virginia—you aren’t provided any kind of sales tax reduction when you trade a vehicle in.
In the other states, though, trading can result in a significant sales tax reduction. CarGurus is headquartered in Massachusetts, so let’s take a look at a scenario there. When you register a new car in Massachusetts, you’re liable for a 6.25% sales tax on the purchase price of the car. If you paid $72,000 for a new Ford F-150, you’re on the hook for $4,500.
But, if you trade a vehicle that’s worth $50,000, the state takes that value right off the top, so your sales tax liability drops to $1,375.
You don't get that benefit if you sell your car outright, so it’s important to think about that tax number, especially if you owe money on your current vehicle.
Don’t Forget the Paperwork
Whether you’re trading, selling your car to a private party, or accepting an Instant Cash Offer, you need to have some paperwork assembled, or at least in the process of being assembled, before you complete your transaction.
The most important piece of paperwork is your car title. Ironically, you may not have the title, especially if you owe money on an auto loan.
41 of the 50 states are known as “Title-Holding States,” meaning that the lending institution that financed your vehicle possesses the title. The non-title-holding states are Michigan, Minnesota, New York, Arizona, Kentucky, Oklahoma, Wisconsin, Maryland, and South Dakota, so if you’re from one of these states, you already have the title in your possession.
With a trade in, either the retailer or the entity providing the offer understands that most cars have existing loans, and most are in title-holding states, so they take care of the paperwork and the waiting behind the scenes. It’s no hassle for you. You just get a check for the balance, or pay off the remaining balance if you have negative equity, and you can move on to the car-buying stage. You never get involved in the messy part of waiting for titles to arrive.
Common Questions About Trading in a Car
Is it smart to trade in a car that isn’t paid off?
If a vehicle is worth more than the amount remaining on its auto loan, then there is no real penalty to trading that vehicle in before the loan has been paid off in full. However, these circumstances are pretty rare, and in situations where the vehicle is worth less than the remaining auto-loan balance, we recommend holding onto the car. Finally, if you’re struggling to make payments on your car loan and are at risk of having the vehicle repossessed, then selling the vehicle in order to purchase a less-expensive model may be a smart move, regardless of the vehicle’s value related to the loan.
What happens to the remaining money owed on a financed car if I trade it in?
When you trade in a vehicle that has not been fully paid off, you’ll be responsible for paying the remaining balance. Generally, this amount will be added to the transaction with the dealership, and the dealership will then be responsible for paying off the loan.
What is the difference between trading a car in and trading a car for cash?
Dealerships will often purchase a car from you even if you’re not interested in buying a car from them. In these situations, you can sell your car—or “trade it for cash”—directly to the dealership.
CarGurus Instant Cash Offer
Until recently, consumers really only had two options when it came to changing their car: Sell privately or trade in. CarGurus now offers a third choice: Sell 100% online. Simply provide some details about your current vehicle (your state, your license number or VIN, the vehicle’s year, make, model, trim level, and condition) and your email address, and in under two minutes, you’ll get a cash offer from CarGurus’ dealer network.
From there, you arrange a pickup time where your vehicle will be collected. Once the vehicle is picked up, you’ll either receive payment by check or direct deposit. The payment time can vary between just a few hours with direct deposit or a few days if by check, which would need to clear the bank’s operations.