When You Trade in a Car for a New Car What Happens If You Owe More Than the Car Is Worth?

If you owe more than your car's value, known as being upside-down on your car loan, the dealer you trade with must pay off your vehicle loan to take ownership of your trade-in. Any additional money you owe toward the loan after the dealer's offer is rolled over to your new car's purchase price.

Dealer Payoff

Expect your dealership to appraise your vehicle and offer a price. The dealer will also call your lender to get your vehicle's payoff amount, which it must pay in full to complete the trade process. The amount of money you owe toward your loan after the dealer's purchase price is added to your new car's purchase balance. For example, if you owe $12,000 on a vehicle that is worth $10,000, the dealer will still pay your lien holder $12,000; the additional $2,000 goes toward your new car's total purchase price.

Tax Savings

Most states offer a tax deduction for trade-in vehicles. If you purchase a new car for $15,000 and have a trade worth $10,000, you are taxed on $5,000 instead. In areas with higher tax rates, your savings can prove substantial depending on the value of your trade-in. Your tax savings can help to decrease your total purchase price. If your tax rate is 10 percent, a trade-in vehicle worth $10,000 saves you $1,000 in tax charges. In this example, you are actually carrying over $1,000 to your new purchase because of your tax savings.

Down Payments and Rebates

You can offer a down payment toward your new purchase to prevent carrying over money to a new loan. You do not have to pay it to your lender. If you attempt to pay your lender to decrease your loan payoff, it can take up to a week before the loan payoff reflects your payment. Pay your dealer instead. If your dealer is offering a rebate, you may be able to use it to cover your negative equity completely. A rebate is an automatic cash discount off of your new car's sticker price. Rebates act as a down payment, so you may not have to provide one at all.

Gap Insurance

If you can't afford a down payment to decrease your negative equity, you may still obtain a loan approval depending on your credit. Most lenders require a full-coverage insurance policy until a loan is satisfied. Your insurance company's payoff has nothing to do with your loan value. If you carry over money to your new loan without providing a down payment, expect to remain in a negative equity position. Gap insurance, which you can purchase at the time you initiate your loan, pays for the remainder of your loan if you should incur a loss; your insurance policy pays your lender for the car's market value. Consider purchasing a gap insurance policy to eliminate your financial responsibility in the event of a loss.