Can I Trade in My Car Owing More Than it's Worth?

Approximately 22 percent of people buying new cars owe more on their old cars than they are worth, according to MSN Money. This is called being "underwater" or "upside down" on the loan. If you are in this situation, you have a few options when shopping for a replacement vehicle.

Roll Old Balance

Some lenders are willing to roll over the remaining balance on your old car loan into your new car loan. For example, your trade-in is worth $6,000 but you still owe $9,000 on the loan. Your new car purchase price is $20,000. The lender might give you a loan for $23,000, which allows you to buy the new car and pay off the remaining balance on the old loan. However, be aware that you will start off owing more on your new car than it is worth, too. In addition, assuming the lender is willing to finance the loan, you will get stuck with a higher interest rate because the loan is not fully backed by an asset.

Use Rebates

New-car dealerships often offer rebates, cash incentives to purchase the new car. If the amount of the rebate exceeds the amount you still owe on your old car, this is a convenient way to start out on the right foot. For example, you might owe $3,000 more on your trade-in than it is worth and select a new car with a $4,000 rebate. Use $3,000 of the rebate to pay off the loan and put the last $1,000 toward a down payment on the new car.

Pay the Balance

If you have enough cash available to pay off the balance of your old auto loan after the trade-in, this is typically a better choice than rolling the balance into a new loan. You will be able to get a better interest rate because your new loan is for an amount less than the cost of your new car. Your monthly payments on the new loan will be lower because it has a lower balance.

Considerations

Unless getting a new car is urgent, you might want to wait until you have paid off more of your car loan before trading in the car. Because cars lose their value more quickly when they are brand new than when they are a few years old, you can catch up on your loan and get it to the point where you only owe the value of the car before you trade it in. Choose a new-car loan with a short term of no more than five years so you will not be as likely to be "underwater" next time.