Trading In Your Car with a Loan: What Canadians Need to Know

So, you're eyeing a new vehicle, but your current one still has a loan attached to it. It's a common scenario for many Canadians, and the good news is, trading in a car you still owe money on is absolutely possible. However, it's not always as straightforward as just handing over the keys. Understanding how this process works, especially the concept of 'negative equity,' is crucial for making a smart financial decision.

What Exactly is Trading In Your Car When You Still Owe Money?

When you trade in a vehicle, the dealership typically pays off your existing loan. If your car's trade-in value is higher than what you owe, that's called 'positive equity,' and the difference can be put towards your new purchase, reducing the amount you need to finance. Great!

But what happens if your car is worth less than what you owe? This is where 'negative equity' comes into play. It means you owe more on your current car loan than the car is actually worth on the market. For example, if you still owe $18,000 on your current car, but the dealership offers you $15,000 for it as a trade-in, you have $3,000 in negative equity.

How Does Negative Equity Affect Your New Loan?

When you have negative equity and trade in your vehicle, that outstanding amount doesn't just disappear. What usually happens is that the dealership rolls that negative equity into your new car loan. So, in our example, if you were planning to finance a $30,000 new car, your actual new loan amount would become $30,000 (new car price) + $3,000 (negative equity) = $33,000.

Rolling negative equity into a new loan can increase your monthly payments, extend the loan term, and mean you're paying interest on a portion of a previous debt. It can also put you in a position where you start your new car loan already underwater, potentially making future trade-ins more challenging.

Is Trading In with a Loan Always a Bad Idea?

Not necessarily! While rolling over significant negative equity should be approached with caution, there are times when trading in a car you still owe on makes sense:

• Small Negative Equity: If the difference is minor, the impact on your new loan might be negligible, especially if you're getting a great deal on the new vehicle or a much better interest rate.
• Reliability Issues: If your current car is constantly breaking down and costing you a lot in repairs, trading it in might save you money in the long run, even with some negative equity.
• Better Interest Rate: If you're currently stuck with a high-interest loan on an older vehicle and can qualify for a significantly lower rate on a new car, the overall cost of financing might be less, even with a bit of negative equity rolled in.
• Safety Concerns: If your current vehicle no longer meets your safety needs or those of your family, upgrading can be a priority.

What Are Your Options If You Have Negative Equity?

If you find yourself in a negative equity situation, don't despair. Here are a few things you can consider:

• Pay Down the Difference: If you have some savings, you could pay off the negative equity upfront. This means you'd only finance the new car's price, avoiding rolling over old debt.
• Wait and Pay Down Your Current Loan: If you're not in a rush, continue making payments on your current car to build up positive equity. The longer you pay, the less you'll owe, and the closer you'll get to a break-even point or positive equity.
• Sell Privately: While it requires more effort (advertising, showing the car, dealing with buyers), selling your car privately often fetches a higher price than a dealership trade-in. This could help minimize or eliminate your negative equity. Just remember you'll still need to pay off your loan before transferring ownership.
• Negotiate Hard: Always negotiate both the trade-in value of your old car and the price of the new one separately. Don't let a dealership bundle them together, making it hard to see the true cost.

Tips for a Smoother Trade-In Experience in Canada

Here's how to set yourself up for success when trading in a vehicle with an existing loan:

• Know Your Numbers: Before you even step into a dealership, know exactly how much you owe on your current loan. Get a payoff quote from your lender.
• Research Your Car's Value: Use Canadian resources like Canadian Black Book, AutoTrader, and Kijiji to get a realistic idea of your car's trade-in value and private sale value. Consider its year, make, model, kilometres, condition, and any special features.
• Maintain Your Vehicle: A well-maintained car with service records will generally fetch a better trade-in value. A clean interior and exterior also make a big difference.
• Don't Focus Only on Monthly Payments: While a low monthly payment is appealing, always look at the total cost of the new loan, including the rolled-over negative equity. A longer loan term to get a lower payment can mean paying significantly more interest over time.
• Be Transparent: Be upfront with the dealership about your existing loan. They'll find out anyway, and transparency builds trust.

Trading in a car with a loan can be a strategic move, but it requires careful planning and a clear understanding of your financial situation. By doing your homework and exploring all your options, you can navigate the process confidently and drive away in your new vehicle feeling good about your decision.