Car Buying Part 2: Trade-in Games

Trade-in Vehicles are a common area of misunderstanding for car buyers.  The misunderstandings are in large part designed by automobile dealers and often result in substantial additional costs to consumers. Consumers can avoid these misunderstandings and additional costs if they adequately prepare and learn to recognize common dealer tactics.

DEALER TACTICS ON TRADE-INS

An example of such a misunderstanding is a radio ad from a popular Los Angeles area dealership, aired on popular stations targeting young listeners, that states “We’ll pay off your car no matter what you owe.”  What they do not explain is that they are paying off your car with YOUR money.

Here is another example.  A young car buyer recently told me that a dealer gave him $5,000 for his trade-in AND paid off the loan, which had a balance of approximately $10,000.  The young buyer thought he received a total of $15,000 from the dealer.  The dealer did not explain, and the young car buyer did not understand that the dealer only paid $5,000 of the loan.  The other $5,000 came out of the car buyer’s pocket.

In order to better understand why these representations are deceptive, a consumer must understand the basics of how a trade-in deal works.  The following is an explanation of the basics in a light designed to help consumers make a trade-in deal work best for them.

DO YOUR HOMEWORK

When trading in your car, you are selling it to the dealer, just as you might sell it to any individual.  As with buying a car, when selling (trading in), you must Know Your Position before you begin negotiating with the dealer.

VALUE OF TRADE-IN: First, you must know what your vehicle is worth (value).  This is an estimate of the price you can expect to receive.  Several websites, such as the Kelly Blue Book website, provide a range of values for used cars based on the year, make, and model of the vehicle, as well as information such as mileage, accessories, and vehicle condition.

These websites usually provide two price ranges for the same vehicle: trade-in value and private-party sales.  Naturally, if you are trading in the vehicle, the trade-in values are the ones that concern you.

PAYOFF AMOUNT OF LOAN: Secondly, if you are still paying for the vehicle you must know the payoff amount for that loan.  The payoff amount will be slightly higher than the principal balance to account for the interest accrued since the last payment.  If the payoff amount is greater than the value of the trade-in vehicle, you will ultimately be responsible for paying this difference, regardless of any wordplay used by the dealer.

TRADE-IN v. PRIVATE PARTY SALE

There are two major differences between a trade-in transaction and a private-party sale.  First, you will almost always receive less value for your car when trading in compared to a private-party sale.

Dealers purchase vehicles with the intention of reselling them.  Therefore, they will not pay the same amount that a consumer is willing to pay.  You are basically selling your vehicle wholesale so the dealer can sell it at retail. The lower value you receive is also justified by the convenience of avoiding the sales process, official documentation process, and collecting money that you would otherwise have to do on your own if you sold the vehicle to a private party.

The second major difference between a trade-in transaction and a private-party sale is the method of payment.  A private-party sale usually includes a hand-to-hand exchange of money and title. On the other hand, when trading in a car there is rarely such a hand-to-hand exchange.  The title transfer and payment will be made outside the presence of the consumer.  This makes it particularly easy for dealers to mislead since consumers do not see firsthand how the value received relates to the purchase contract for their new vehicle.

RECEIVING PAYMENT FOR THE TRADE-IN

The trade-in value (price) is negotiable and, of course, the dealer will try to pay the lowest possible value.  Once you have settled on the value for the trade-in vehicle, there are several possible scenarios, which will determine how the proceeds of the trade-in transaction are applied to the new car purchase.

1) PAID OFF LOAN: If the loan for the trade-in vehicle is already paid off, the entire value of the trade-in will be applied to the new car as a downpayment.

2) EQUITY: If a balance is still owed on the trade-in loan, but the value of the trade-in is higher than the loan balance, the amount of value above the balance is equity.  In this case, the balance will be paid off and the equity will be applied as a downpayment toward the new car.

3) EVEN TRADE:  If the value of the trade-in is equal to the amount owed on the loan, the entire value will be used to pay off the trade-in loan. There will be no equity or negative equity as described next.

4) NEGATIVE EQUITY:  If the loan balance is higher than the trade-in value, the difference between the balance and the value is “negative equity”.  This situation is commonly referred to as being “upside down”.  In this case, the entire value of the trade-in vehicle will be applied to the loan balance and the “negative equity” will be added onto the purchase contract for your new car.

In the case of negative equity, any downpayment on the new car will first be applied to pay off the negative equity.  If the downpayment does not cover all of the negative equity, the car buyer must borrow enough money to pay for the new vehicle and pay off the remaining negative equity.

PAYMENT PROCESS: Once a loan for the new vehicle purchase is approved, the finance company sends the dealer a check for the entire amount of the loan.  The dealer then pays off the trade-in vehicle loan, if any, using the funds received from the finance company.

The dealer does the physical act of sending the payment to pay off the loan on the trade-in vehicle. However, that does not mean the dealer is using its own money.  The money used is: a) the amount the consumer received from selling the trade-in vehicle to the dealer, and b) in the case of negative equity, the consumer’s downpayment or the additional money borrowed by the consumer on top of the new car loan or both.

DEALER TALK EXPLAINED

When the popular southland dealer says that it will “pay off your loan no matter what you owe,” it does not mean the car buyer is receiving any additional value from the dealer.  The ad is a play on words, and possibly false advertising.  Although the dealer physically sends or transfers the money that pays off the loan for the trade-in vehicle, that money is YOURS.

Likewise, when the young car buyer told me the dealer gave him $5,000 for the trade-in AND paid off the $10,000 balance, he did not receive $15,000 in value from the dealer.  He received only $5,000 of value for the trade-in vehicle.  The dealer used the $5,000 that it paid for the trade-in vehicle and another $5,000 from the car buyer’s loan, to get the $10,000 needed to pay off the balance owed on the trade-in.  The dealer then physically sent that $10,000 to pay off the loan on the trade-in.

These types of deceptive ads and tactics are largely designed for and targeted at young and inexperienced consumers who are “upside down” (negative equity) on their car loans.  The prospect of getting rid of a low value car, getting out of an expensive loan, AND getting a new car is particularly attractive to individuals in this situation.  Unfortunately, however, trusting these dealers can only compound the problem and create many years of credit woes.

In the end, if the dealer’s offer sounds too good to be true, it usually is. Do your homework in advance so you know the value of your car and the payoff amount.  You should then be able to spot and flush out any unrealistic dealer promises.

Also keep the trade-in vehicle clean, and, very importantly, do not tell the dealer you are trading in until after you have settled on the purchase price for the car you are buying.  Dealers like to minimize the significance of the trade-in transaction and confuse consumers as to the actual value they are receiving.  This trade-in should be treated as a separate negotiation.  This is discussed in more detail in “Car Buying Part 5: Negotiations”.