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How Does Trading In A Car Work?

Hanna Kielar5-minute read
January 20, 2022

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If you've had your vehicle for a long time and feel ready for something new, you may be wondering "How does trading in a car work?" This guide explains everything you need to know when trading your car in at the dealership.

What To Expect When You Trade In Your Car

Trading your vehicle in at a dealership is typically easier and more convenient than selling it to a private party. You won't need to find your own buyer, take the time to vet them as potential scam artists, or take the risk of exchanging large amounts of money with a stranger. Dealers can guarantee a secure, stress-free transaction and will take care of most of the paperwork for you.

This convenience can come at a cost, however – your car's trade-in value may be less than what you'd get by selling privately. Still, if you trade in a car to the dealership, it has a number of advantages. A few of the biggest perks include:

  • They'll handle vehicle registration for you. If you plan to sell your car in a state other than the one it's registered in, figuring out the paperwork can be complicated. Dealers know what documents to file with the DMV and can take care of vehicle registration on your behalf.
  • They'll work with your existing auto loan financing. Car dealers will pay off the amount you owe on your current vehicle's loan and get the title directly from the lender. If you have positive equity in the car, it can be used as a down payment on your next vehicle.
  • You could get a break in sales tax for your new car. When you trade in your car at a dealership, the tax laws in some states allow you to deduct the value from the total purchase price of a new vehicle. This can add up to significant sales tax savings for you.

If these perks pique your interest, and you’re asking yourself, “Great, so how do trade-ins work?” let’s go through a quick rundown of the process:

  1. Find a new car that fits your budget
  2. Get an appraisal of your current car's resale value
  3. Compare and select the best dealer offer
  4. The dealer accepts the trade-in and pays off your loan in full
  5. The dealer transfers the new car's title to your name

How To Trade In A Car That Is Not Paid Off

In April 2020, the percentage of new sales with a trade-in that had negative equity hit 44%, with an all-time high average negative equity of $5,571. These figures indicate that trading in a car with a loan is an increasingly common practice, even for buyers who owe more than their vehicle is worth.

Before you step into a dealership, it's important to know how much your car is worth so you'll get the best value when trading it in. Factors that affect a vehicle's valuation include its age, overall condition, mileage and market value for the model. There are many online resources for quickly determining an estimated value for your car, but that may differ significantly from an actual dealer that can inspect it in person.

Once you have an idea of the value, compare it to your outstanding loan balance to determine how much equity you have in the vehicle. Knowing whether you have positive or negative equity is key to making informed decisions when trading it in at a dealership.

Trading In A Car With Positive Equity

Your car has positive equity if its value exceeds the amount remaining on your loan. For example, if your vehicle has a trade-in value of $10,000 and you owe $5,000 on your loan, then you have $5,000 of positive equity. When you trade in your car, the dealer pays off your existing loan, and any positive equity can be applied to the purchase of your next vehicle.

If a dealer wants to buy your car, they'll move forward with negotiating a trade-in price. Be sure to keep your car's estimated value in mind to get the fairest deal. Some dealers will attempt to have you prioritize the monthly payment for the new vehicle, a negotiating tactic that can help dealers gauge your top-end budget. For this reason, it's best to stay focused on the trade-in price for your current car before negotiating price on the new purchase. Consider shopping around at several dealerships during the best times to trade in a car for the most profit.

Trading in a vehicle with positive equity can also save you hundreds or thousands of dollars in sales tax. In many states, you're only required to pay sales tax on the difference between the price of the new vehicle and your car's trade-in value. As an example, if the new car costs $30,000 and your trade-in value is $10,000, you would only pay sales tax on $20,000.

In other states, such as California, you're required to pay the full amount of sales tax regardless of your trade-in value. This means if you buy a car worth $30,000, you'll be taxed on that $30,000 at California's 7.5% vehicle sales tax rate (additional local taxes may also apply).

Trading In A Car With Negative Equity

If you owe more on your loan than the vehicle is worth, you have what's called negative equity (also known as upside-down equity or an underwater loan). It can be tempting to trade in your vehicle to get rid of your loan, but it's not advisable to do so in most cases. If you still owe on your old car after trade-in, many dealers will simply roll that debt into the new loan on your new car, so you'll still be on the hook for paying it anyway.

For instance, if your car is worth $10,000 and your remaining loan amount is $13,000, you have a negative equity of $3,000. Assume you get a loan for a new car valued at $15,000. If the dealer tacks that $3,000 in negative equity onto the new loan, you're responsible for paying back both amounts for a total of $18,000.

Refinancing your loan is one way to reduce negative equity. You might be able to transfer part of the loan to a credit card with a 0% APR introductory rate. Then, at the end of the introductory period, refinance the loan with a peer-to-peer lender or local credit union.

In some situations, you may still choose to trade in a car with negative equity. If your car gets poor gas mileage, requires expensive repairs or you need a bigger vehicle to accommodate your family, trading it in may be the right decision for you even if it means accepting some financial loss.

The Bottom Line: Trading In Your Car Can Be A Smart Move

When you're ready for a new car, there's no need to pay off your current loan first. Trading in your car to a dealership spares you the headache of selling privately, and if you've got positive equity, you could save hundreds or more in sales tax. Get started now by finding your car's value and checking your instant cash offer with the Rocket AutoSM Sell My Car tool.

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Hanna Kielar

Hanna Kielar is a Section Editor for Rocket Auto℠, RocketHQ℠, and Rocket Loans® with a focus on personal finance, automotive, and personal loans. She has a B.A. in Professional Writing from Michigan State University.