One of the more common questions I get from car buyers happens when a new car catches their eye and they are no longer in love with their old vehicle. The thought of having a shiny new ride is hard to resist, but what happens when you still owe money on your old car and you owe more than your car is worth. This condition is often called an upside down loan meaning the vehicle that you still owe money on is worth less than the principal or outstanding balance of the loan. That’s when they ask how to trade your car with an upside down loan.
Actually having an upside down car loan is a very common occurrence today when a person buys and finances a vehicle with a very small or no down payment at all. Automobiles depreciate rather quickly and unless you put down a sizable down payment or have a trade-in that is worth several thousand dollars there is very good chance you will end up with an upside down loan during the term of the loan up until the last year of the term.
The Process of Trading a Car with an Upside Down Loan
People trade their cars in every day that owe more on them than they are worth. There are a few conditions that must be met for a person to do this, one is that you must have good credit or they have the cash to pay off the outstanding balance. Also the amount of their upside down loan is a reasonable amount which will depend upon the vehicle they are purchasing. The way this usually works is that the amount that is outstanding on the old car after they take into consideration the value will be in to the loan of the new car. If the balance is just a few thousand dollars and the buyer has good credit it usually not a problem. However there are times when a person may be many thousands upside down and the lender will not allow that outstanding balance to be rolled over onto the new loan.
To give you an example let’s say the vehicle you want to purchase is $20,000 and your trade-in is valued at $10,000, but your outstanding loan on your trade-in is $12,000. Therefore you are upside down by $2000. The dealer will apply the $2000 which is outstanding to your new vehicle loan which makes the amount financed $22,000. This is very common practice, but if you do not have good credit the lender will not allow you to add the $2000. Auto lenders have parameters which dictate how much they will finance of the new vehicle depending upon your credit score. All lenders have rules and regulations, but to give you an idea what I’m talking about if you had a great score of let’s say 780 the lender may allow you to finance up to 140% of value of the vehicle. Now if you had a credit score of 680 the lender may only allow you to finance 100% of the new vehicle and if your score was even lower then they would only finance 80% of the vehicle which would then require you to have a 20% down payment and pay the $2000 outstanding balance which caused your loan to be upside down.
According to the above example if your loan was upside down by $9000 you would be required to pay $1000 up front because the bank would only finance $28,000 which is 140% of the $20,000 car that you want to purchase. In this scenario the bank would require you to have excellent credit. That should give you a pretty good idea on how to trade your car with an upside down loan. The best way to avoid being caught with an upside down auto loan is to put down as much money as possible and you purchase a vehicle. A good rule of thumb is 25% of the amount financed to avoid being in a negative equity position the next time you trade-in your car.
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