How Does Trading In A Car Work

If you’re looking to buy a car, and have an old vehicle that you’d like to sell, one option is to trade it in at the dealer where you’re buying your new car.

Essentially, what you do is: you sell your used car to the dealer, but they don’t pay you in money — the value of your old car gets taken off the value of a new vehicle that you want to buy.

Let’s explore how trading in your car works in practice, as well as the upsides and downsides of trading in your car, and contrast this to selling your car independently of dealerships.

The Basics

Before we begin, you should know that trading in your current car at a car dealership might not be the best choice for everyone — there are other options, which we will also cover.

Here’s a quick overview of the most common reasons why people choose to trade in their cars:

  • It Can Make Buying A New Car Less Expensive
  • If You Have A Car Loan On Your Old Car, The Trade In Difference Can Sometimes Cover Most Of It

And here’s a quick tip before you rush into your nearest car dealership:

  • You Can Probably Get More Money By Selling Your Car To A Private Party

With this said, let’s move on to the main point —

What You Need To Know About How Trading In Your Car Works

When you trade in your car to a dealership, its value is subtracted from the price of the new car that you’re buying.

Also, when you trade in a car with a loan (if your old car isn’t paid off entirely), the dealer takes over the loan and pays it off. The dealer also handles paperwork like the “transfer of the title”, which establishes legal ownership of the car.

To trade in a car that’s not paid off, you need to bring the following things to the dealership:

  • Your Driver’s License
  • Your Vehicle Keys And Any Remotes
  • Vehicle Registration
  • Proof Of Insurance
  • A Printout Of Your Trade-in Value
  • Loan Information, Including Payoff Amount And Account Number

It’s important to keep in mind that both the price of the new car and the value of the trade-in are very negotiable. To get an overall good deal, you will need to get a good interest rate on your new loan and a fair price for both the trade-in and the new car. Before you go to the dealership, look for and use an “online car loan calculator” to estimate these numbers and see what your new monthly car payment will be.

Trading your car into a dealership means you’re selling it to them and hoping you’re getting the best possible sales price. Much of the preparation is the same as a private sale. One key upside here is that you typically don’t need to have your car repaired before you sell it, because the dealer will do all the work of refurbishing it.

Positive And Negative Equity Car Trades

As we’ve already established, you can trade in a vehicle even if you still owe money on its loan. In fact, it is very common for dealers to take care of their clients old loans. They will pay off the remaining loan balance on your trade-in and obtain the car’s title directly from the lender.

If you have positive equity in the vehicle you’re selling (meaning: your current car is more expensive than your remaining car debt), it will be used as a down payment of your new lease or new vehicle purchase.

You can even trade your vehicle into a dealership if you have negative equity. Having negative equity means that your car debt is larger than your cars value.

When you owe more than the car is worth, it’s sometimes called ‘being underwater on the loan’.

Dealing with an underwater car loan isn’t complicated, but there are a few things to watch out for. Let’s discuss why trading your current vehicle with negative equity may not the most ideal option.

But firstly, let’s talk about:

Trading In A Positive Equity Car

Let’s cover a more simple scenario — you have positive equity in your vehicle.

If you owe $3,000 on your car, and it’s worth $5,000 as a trade-in, you now have $2,000 of equity — and you can apply that money directly to the purchase of your next car. This equity is deducted from the previously negotiated price of the new car that you’re bying.

In addition to any equity applied to the new car purchase, you can also make a down payment to reduce the overall balance of the loan, but you will need to provide cash or get an auto loan to pay the rest of the purchase price of the car.

The value of the trade-in will be listed in the contract for your new car. Tip: make sure that you’ve received the full agreed-upon amount that you negotiated.

Trading In A Negative Equity Car

If you’re upside-down on your car loan, it’s actually better to postpone your new car purchase and trade-in until you pay off your loan — or at least until you have positive equity.

However, if you’re struggling to make car payments, trading in your vehicle can allow you to buy a much more affordable new car or even an inexpensive used car. In that case, you’ll need to give the dealer your trade-in, plus the amount of the negative equity.

For example, if you owe $10,000 on a car with a trade-in value of $8,000, instead of being $10,000 in debt, the trade-in credit will cover most of the loan and you’ll pay the dealer the $2,000 difference.

But be careful: Even tough the dealer will almost always happily suggest rolling the negative equity into the loan for your next car — this is unwise. It will immediately make you upside-down in the new loan. This also means that you’re creating a larger loan amount and paying more interest.

This means that you’ll be in even more debt than before.

However, if you need a car but don’t have the money to pay off the negative equity, and if you’re in trouble with your current car payments, it might be worth the risk.

This can be the case if your new loan (either from an independent lender or the dealer) has a lower interest rate.

If you decide to downsize by purchasing a cheaper car, your payments may become more manageable, even if you roll the remaining debt into a new car loan, creating new debt.

As you set up your new loan, avoid extending your loan term for more than 60 months for a new car or 36 months for a used one. Also, know that you will probably get a better price selling your car privately than trading your car in.

If you plan to trade in a car that you still owe money on, contact your auto loan lender first and ask for your payoff amount (which could generally be slightly higher than your remaining balance).

Consult an online pricing guide and look up the current trade-in value of your car. Guides like Kelley Blue Book and Edmunds are the go-to choices for most people who sell their cars independently.

Compare different values. Subtract the payoff amount from your car’s current trade-in value.

Though the final trade-in price can be negotiated, you will now be certain whether you have positive or negative equity in your current vehicle.

Leasing

Contrary to what some believe, you can get leasing even if your current car isn’t paid off. By applying the money that you receive from a trade-in as the down payment on a lease, you can reduce the size of your monthly lease payments, the amount due at signing, or both.

To show you how to do that, let’s establish how leasing works.

Car buyers pay the entire negotiated price of the vehicle. They usually get a car loan from a lender and finance what they owe when they purchase. However, lease customers only pay for the depreciation that occurs during the term of the contract, plus interest (called the “money factor” in leasing) and fees.

That amount is broken down into a down payment and a series of equal monthly payments. When the lease ends, the vehicle is usually returned to the place where the contract originated. Some leases let you take the vehicle to another of the brand’s franchised new car dealers.

Let’s use another example to illustrate how you can use your used vehicle’s trade-in value to cover part of the lease. Say you currently have a truck with no negative equity. It has a trade-in value of $10,000, which you want to use to finance the lease of a new model. You’ve also negotiated the price of the new vehicle (called its capitalized cost in leasing) down to $40,000, with a residual of $24,000 after a three-year lease. In effect, you have to pay $16,000 over the course of the loan, plus interest and fees.

Now apply your $10,000 trade-in to the lease deal. That brings the money you owe down to just $6,000, plus interest and fees. Even if you pay nothing more at signing, with a money factor of .0025 (equal to an interest rate of 6 percent), your monthly payments would be $183 per month, plus fees.

From this example, you can see just how affordable leasing can be if you have a high-value trade-in to put toward your lease contract. Keep in mind, however, that at the end of your lease you won’t have any equity to put toward a down payment on your next car.
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It’s rarely a good idea to trade in a leased vehicle. However, if the trade-in value of your vehicle is significantly higher than the buyout cost of your lease as you near the end of the car loan, you can trade in your leased vehicle (or sell it yourself), pay off your contract, and use the cash as a down payment for your next car.

You can usually get more money out of a private-party car sale, so you might want to try to sell the car yourself and get its highest resale value. Be sure to check with your leasing company to ensure that there are no prohibitions on selling or trading in the vehicle before it’s paid off completely.

Selling Your Car Privately

Trading in your car to a dealership may not always be the best way to get the best value from your used car. You might get more money if you sell your used car to a private party.

Generally, the amount of money you can get by trading in your car is less than you can get by selling it to a private party.

However, selling your car by yourself definitely requires more work (especially if you’re still paying off a car loan).

What’s important to note here is that a private sale is a time-consuming process. In this case, marketing the vehicle becomes your responsibility. You must also show it to potential buyers for their appraisal, negotiate the price, and do the paperwork to finalize the sale and transfer the title.

A relatively easy way to reach potential buyers is by advertising on one of the major used car websites, although, selling through dealerships is a bit more common in the US, which means that you’ll probably have fewer potential people to sell to privately.

The Positives and The Negatives Of Trading In Your Car

Every coin has two sides. Let’s talk about the main advantages as well as the main disadvantages of trading in your vehicle in a dealership where you are purchasing your next car.

The Positives

It’s Easy

All you have to do is go to the dealership where you plan to buy or lease your new vehicle, tell the car salesperson that you want to trade your old car in.

After they give it a test drive and evaluate it, the dealership employee will make you an offer. This generally isn’t a cash transaction, but a discount for the new car that you’re buying. If you accept their offer, simply conclude the deal by signing the car’s title over.

It’s Efficient

Trading in your car is all done in a single location. You drive your old car to the dealership and drive your new car home.

You can have a car loan arranged by a dealership, but unless you have a pre-approved offer in place from an outside lender, the dealer will have no incentive to find you a loan that’s a good deal.

Basically, the dealership can be a one-stop shop for finding a new car, securing a car loan, and trading in your old model — just make sure that you’re getting a good deal on each part of the transaction.

You Can Pay Off Your Existing Loan

As you already know by now, you can even trade your vehicle into a dealership if you have negative equity (trade in your vehicle even if you still owe money on its loan).

The dealership will pay off the remaining loan balance on your trade-in and obtain the car’s title directly from the lender. If you have any positive equity in the vehicle, it will be used as a down payment toward your new lease or purchase.

No Paperwork

Selling a car requires a ton of paperwork, but the dealership will take care of the paperwork for you if you trade in your car. All you need to do is sign the papers, albeit not completely free — you’ll be required to pay a document fee for this convenience.

You Can Save on Sales Tax

One key benefit to trading your car in at a dealer is saving money on the sales tax. In many states, the trade-in value can be deducted from the new car’s price.

For example, let’s assume that you don’t have any negative equity or otherwise owe money on a car loan, to make it simple. You want to buy a brand-new vehicle, and you’ve negotiated a price of $35,000.

You also have a used car that you want to trade in. The dealer offers $10,000 for your trade-in — your net payment is then $25,000. In many states, you will pay a sales tax on the $25,000 instead of the new car’s regular $35,000 value.

It’s important to do the math to determine whether these sales tax savings you get by trading in the car are better than what you can get by selling independently.

The Negatives

After considering the advantages of trading your car in the dealership where you’re planning on buying your next car, let’s also look at some flaws of trading in your car.

You Won’t Get The Best Value For Your Car

When you trade your car in at a dealer, you will probably only be offered the wholesale value of the vehicle — often significantly lower than the price you can get if you sell it to a private party.

If you want to get the most value out of your used car, and you have the confidence in your selling ability to do so, it’s best to sell your old car yourself.

Depending on the vehicle’s age, class, condition, and mileage, the difference between its wholesale and private-party resale value can range from a few hundred to thousands of dollars. If it’s just a couple hundred bucks, it’s probably not worth the time and hassle of selling it yourself, but if you can get a lot more, the dealership isn’t a good choice.

It Can Become Confusing

Every car deal has three key components: the price of the vehicle, the trade-in allowance, and the terms of the auto loan or lease. In most cases, salespeople will want to blend them into one package and sell you on the amount of each month’s car payment. That’s a great way to sell a vehicle, but it can be absolutely confusing for buyers.

As a buyer, you want to keep those components as clear and distinct as possible. By adding a trade-in to the same transaction as the purchase of a new car, a dealer can make the vehicle’s price look amazing. They do this by lowballing your trade-in value. Alternatively, they can offer consumers a great price by marking up the price of the new car or the price of financing it. With so many numbers floating around, it can be difficult to estimate the true value of a trade-in offer.

The simplest way to keep your negotiation with a car salesperson focused on the price of the new car is to sell your used car yourself and get preapproved for financing before you start car shopping.

If Your Car Is “Severely Underwater”

When you owe more on your vehicle than it is worth, you have what is called having negative equity, being upside-down on your loan, or being “underwater”. In this situation, trading your vehicle in at a dealer makes less financial sense. If you can’t sell your current car and use that money to pay off your existing loan, the cash to pay it off must come from somewhere else.

Here’s an example: You owe $15,000 on a car that the dealer is only offering you $12,000 to trade in. If you sell, that means you will immediately have to pay $3,000 to your lender. If you have the cash to cover the payoff amount of your loan, then that’s fine.

However, if your budget is tight, then your options are more limited. Many car dealers and lenders will be more than happy to “help” you out by adding the $3,000 existing balance onto your new car loan. Lenders will use the extra cash to pay off the loan on your old car. Unfortunately, that is a financially treacherous way to buy a new vehicle. With rare exceptions, you’ll start your new car loan with negative equity before you even leave the lot.

In essence, you’ll be paying for two cars, while you can only drive one of them. Since your new vehicle will rapidly depreciate the moment you drive it off the lot, it will force your upside-down car loan even further underwater.

Expanding on our earlier example, we’ll say that your new car costs $20,000. Add the $3,000 from your old loan, and the balance of your financing is $23,000. Next, assume that a new car depreciates 10 percent the moment that you drive it off the lot, or $2,000 in this case (it’s likely more, on average). Before you even get your new car home, you will owe $5,000 more than it is worth. In other words, you’ll have $5,000 in negative equity.

If you total your car or it is stolen while you have negative equity, you are still responsible for paying the entire loan balance back to the lender. Even if you have gap insurance to cover the amount you’re underwater, many policies will not cover balances rolled over from previous auto loans. Having any hiccups in your life that cause you to miss a payment or go into default on an underwater auto loan will quickly appear on your credit reports and devastate your credit scores. Buying a car when you have bad credit will result in higher interest rates and stricter loan terms.

If you have an upside-down car loan but want a new car, it might be a good idea to sell the old one yourself instead of trading it in.

Another option is to put off the purchase of a new or used car until you have paid off enough of the existing loan that you are no longer underwater.
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In Short

Trading in your car with the dealer makes the process much simpler, but you will most likely get less money than if you sold it to a private party. You’ll have to decide whether the convenience is worth the difference in price.

You’ll likely get a better deal if you sell your car privately, but it will take time and effort.

Researching your specific situation is key here. By setting a realistic price and by knowing the precise value of your trade before you approach a car dealer or try to sell your vehicle independently, you will be confident enough in your negotiation and you’ll most likely achieve whatever you’ve planned.

With these options combined with financing your vehicle through a system called lifestyle banking, you can get a new modern car quickly and save money in the process. Watch our masterclass to get familiar with how such system works.