Key takeaways

  • If you owe more than the car is worth, meaning you have negative equity, you should pay off a car loan before you trade it in.
  • If you have positive equity on the car, meaning you owe less than the car is worth, you can trade it in and use the positive equity towards a new vehicle.
  • If you have negative equity, look into alternatives, like selling the car privately, breaking even between the car's worth and the amount you owe or refinancing the loan.

If your car is worth more than you owe on your car loan, trading it in before it’s fully paid off isn’t a big deal. But if you have negative equity, meaning you owe more than the car is worth, it’s best to pay off your car before the trade-in. Rolling over negative equity into a new loan could mean paying a lot more money than you need to.

When to pay off your car before trading it in

Often, it’s best to pay down or pay off your auto loan before selling it or trading it in. The main concern is whether you have positive or negative equity on your loan. With negative equity, you will always want to pay off your auto loan before you trade in your car.

Positive equity

Positive equity on an auto loan means that you owe less on the car than it is worth. So, if you have $10,000 left on your loan, but your vehicle is worth $15,000, then you have $5,000 in positive equity. If you choose to trade in your car, the first $10,000 will pay off your existing loan. The remaining $5,000 in positive equity can go toward your next vehicle as a down payment, reducing the amount you need to borrow.

When you have positive equity on your loan, you don’t have to pay off your car loan in full before trading it in unless you want to. You will receive enough money from trading in to pay off the loan.

Negative equity

Negative equity is the opposite. If you still owe $10,000 on your loan, but your vehicle is only worth $8,000, you’ll have $2,000 in negative equity. This is what lenders and financial advice columnists call “being upside down.”

It’s a position you don’t want to be in. If you trade in your car with negative equity, you’ll have to pay off the remaining loan balance out of pocket before trading it in or roll the negative equity into your new loan. We don’t recommend rolling over negative equity into a new loan because it can put you at risk of becoming upside down on the new loan.

You’ll need to borrow extra money on the new loan, meaning a higher monthly payment. Plus, you’ll be in a place where you owe even more on a vehicle than it’s worth, which doesn’t lead to long-term financial gain.

Other considerations

A couple of other factors can complicate this decision. Consider the current ownership costs of the vehicle. If it’s older, you may be sinking more money into expensive repairs. Or, if it has poor gas mileage, it may be costly to operate. In these cases, it might be good to trade in the car before it’s paid off to save on vehicle costs.

Also, look into whether your lender charges a prepayment penalty. Check your loan contract. Some loans penalize paying off the loan early or even extra payments. Average prepayment penalties are 2 percent of the outstanding balance, so you may have to decide whether to absorb the fee.

How to trade in a car that is not paid off

People trade in and sell cars that have liens on them frequently. In fact, dealerships may advertise paying off your car for you when you upgrade to a new model. But selling a car you owe money on is more complex than switching one vehicle for another.

  1. Research your car’s value on sites like Edmunds and Kelley Blue Book. Look at vehicles with the same trim and compare average price points in nearby areas.
  2. Calculate your budget for your next car and how much you owe on your current one. Ask your loan servicer for a payoff statement, letter or quote to see how much it would cost to pay off the loan in full. Consider alternative options if you owe more than you’re likely to get through trading it in. You might also look at our tips on how to boost your car’s trade-in value.
  3. Gather maintenance records and other paperwork. This may help increase your car’s value as a trade-in by proving that it’s been taken care of.
  4. Compare trade-in offers from dealerships — you don’t have to go to one place. Everyone may use the term “trade-in,” but really, you’re selling your car. You can negotiate selling price and shop around for different quotes to get the best deal. Dealerships will often contact your lender and handle the paperwork for trading in a car with a loan.
  5. Get everything in writing, especially if a dealership promises to pay off your loan. Be sure you have a copy of the offer. You’re still responsible for paying off your loan, so follow up and ensure your lender is paid after you trade in your car.
  6. Start making payments on the new loan. You might want to look into autopay to make this process easier.

Alternatives to trading in a car

If you’re upside down on your loan, trading it in is unlikely to be the best course of action. Instead, consider selling your car to a private buyer, paying the loan down or refinancing it at a lower rate.

Working with a private buyer rather than a dealership may help you sell your car for more. However, you must handle paying off your lender and transferring the title yourself. Dealerships usually do this on your behalf, so it may be an added hassle.

Paying down the loan may not be an option for most. But if your payments aren’t currently breaking the bank, set aside some extra money to break even. This way, trading your car in won’t involve rolling any remaining loan balance into your new auto loan.

Finally, try to refinance at a lower rate. Don’t extend your loan term in an attempt to lower your payment — this increases the chance that you’ll go upside down. Instead, reduce the total amount you have to pay.

Next steps

Provided you aren’t upside down on your loan, trading in your car for a less expensive option may be the right solution. If you do have negative equity, try refinancing instead — it may allow you to lower your interest rate so you pay less overall. Most importantly, don’t roll your remaining loan into a new one. Work with your lender, sell your car or find an alternative option to avoid taking on additional debt if you can help it.