Trading in a car for which you owe more than it’s worth can be quite costly. Although the dealer may tell you it is willing to pay off your old loan -- and this is technically true -- most incorporate negative trade-in equity into the new loan. Therefore, in addition to paying for the new vehicle, you also continue paying on the old loan, which in turn increases the term and monthly payment. Although the most cost-effective option is to wait until you’re in a positive equity position, there are tactics that can lessen the financial impact.
Assess the Situation
Determine how far upside-down the loan is before you start shopping. Review the amortization schedule that came with your loan documents or contact your lender to get the current payoff. Next, find out how much you can reasonably expect to get during trade-in negotiations according to your vehicle’s age and condition. Appraisals tools on Internet sites such as Kelley Blue Book and Edmunds are helpful for accomplishing this task.
If you don’t have a specific make or model in mind, look for vehicles that have incentives such as a cash-back allowance, a loyalty bonus, college graduate or first-time buyer discount, or low-interest financing. As an alternative -- especially if you’re purchasing a used car -- look for deals like an extended warranty or a free gas deal that might reduce long-term ownership costs. Although these may not eliminate negative equity, they can make it less expensive in the long-term.
Roll the Negative Equity
Roll negative equity from a trade-in into a new loan after getting the information necessary to make an informed decision. Use an online negative equity auto loan payment calculator to find the long-term costs. The Federal Trade Commission recommends that you also ask the dealer specifically how negative equity is being treated in the deal. Read the contract carefully, and don't sign it until you fully understand all of its terms and conditions.
Keep the term of the new loan as short as your budget will allow. The longer the loan, the more expensive negative equity becomes. Interest rates also make a big difference, so if the economy or your credit rating results in a loan with a high interest rate, look into refinancing after the first year. Edmunds suggests that you first check with your bank or credit union. Then, compare the rate and term with other local banks and online lenders. Most banks and online lenders have auto loan refinance calculators that help you estimate your savings and compare interest rates.
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