Given the nature of today’s auto market, it is not often people are willing (or able) to pay cash for a new or used car. With tons of new financing options, it has never been easier to get into a new ride.
While the upfront cost of buying a car has decreased, the need to utilize financing has only grown as a result. As you can imagine, a lower down payment does not mean the car is cheaper. In fact, a low or non-existent down payment leads to increased monthly payments with ever growing interest costs.
As people buying cars with financing increases, the number of people regretting their purchase increases as well. With only a handful of options, trading in a financed car seems like the best option.
How Does Car Financing Work?
Let’s assume you just bought a car with financing for $10,000. Since most dealerships these days only require a small down payment, if one at all, the large majority of the cost will be on a loan. So if you paid a $500 deposit, the remaining $9,500 will be financed and have interest applied to it over the course of your loan.
As you make your monthly payments, only a portion of the funds go towards paying down the principal. The remaining amount covers the accrued interest on your loan. Depending on your interest rate and term length, you may pay anywhere from $500 to $5,000 beyond the purchase price in interest payments.
What Can I Do with a Financed Car?
Needless to say, you will be paying much more than the $10,000 purchase price of the car over the course of your loan. With this in mind, the value of your car is less than the financial obligation you have to pay. This is known as negative equity, which makes selling a car with a loan a bad idea.
Why? Because the value of your car is less than what you owe, so you will still owe the difference even if you sell your car at full value. So what is the next best option?
Can I Trade In a Financed Car?
Since you will be on the hook for the loan whether you sell your car or not, you will need another option to have a mode of transportation. One of the most common methods is to trade in a financed car for another.
Yes, it is possible to trade in a car that you have financed with a loan, but there is some math you will need to do to not dig yourself a deeper hole. For example, if you want to trade in a Tesla, you may have a higher loan balance than the car is worth or vise versa.
When Should I Trade In My Financed Car?
The first question is “how soon can I trade in a financed car?”. The answer is as soon as you want, because there is no time limit for how soon you can swap your car on loan for another one.
But trading in a financed car too soon comes with the same implications as selling a car with negative equity. You will still need to cover the difference in car value and the accrued interest on your loan. So the sooner you trade in your car with financing, the more likely you will be covering a remaining loan balance.
If you wait to trade in your car until you have paid down the loan substantially, you will be in a much better position financially.
Think about it – once your car is worth more than the amount you owe on it, when you choose to sell your car or trade it in, you will have a positive equity position in the car. This means that you will either make money on the sale or have a positive value to put towards your new trade in.