If you're thinking of buying a car, you have some decisions to make regarding how to best pay for the purchase. Along with using cash on hand or taking out a vehicle loan, you can opt to trade in a car you no longer need and have the trade-in value applied toward your next vehicle purchase.
Doing a trade-in requires some research beforehand to make sure your car has value and to deal with any remaining loan on the vehicle. Use this guide to learn about ways to pay for a new or used car purchase and how to go through the trade-in process along the way.
Basics of Car Buying
Buying a car offers the benefits of having a vehicle that fully belongs to you once it's paid off and the convenience that comes with being able to use and modify the car as you'd like. You can purchase cars through dealerships of all sizes as well as through individual sellers, and you can even have cars customized through the manufacturer. While sellers state a desired price, you can often negotiate to get a better deal and take advantage of discounts. Taking measures like going through the trade-in process for your old vehicle can also help financially.
Depending on your preferences and budget, you could buy a new car that comes in great condition and has the latest features that make driving enjoyable and safe. On the other hand, you could buy a used car that comes with a lower price tag (because depreciation has already taken effect) but in a condition that can depend on age and the maintenance that past owners performed. Warranties can help offer peace of mind for both new and used cars, while vehicle inspections and history reports can uncover potential problems with used models.
Read More: How to Buy a Used Car
How Car Leasing Differs
Keep in mind that buying a car works much differently than the alternative of leasing. While both options provide you with a vehicle to use, the money you pay with a lease goes toward compensating the lessor for the depreciation sustained in use, so you're renting rather than working toward owning the car. Leasing also comes with restrictions for customization and restrictions on how many miles you can drive, with fees for breaching the terms. At the end of a lease, you may have a buyout option, but it's usually more expensive than just buying the car from the beginning.
Buying a Car With Cash
Buying your used or new car with cash can save you from the hassles involved with obtaining financing and associated costs like interest charges and fees. It can also be the easiest option when your credit score is too low for a car loan with an affordable interest rate or when you want to purchase a vehicle from a private seller rather than a dealership. In some situations, you can hand over cash to the seller, but you may use a certified check for large purchase amounts.
You can get the cash to buy a car from your existing savings or from the private sale of your old car. However, there are pros and cons to using cash. Parting with a large amount of cash can be risky unless you still have a lot of reserves left. Taking the money from certain sources, like retirement accounts, can cause problems both now with early withdrawal fees and later when you need the money for living expenses. When you'd qualify for a zero-interest offer, using cash means also not being able to invest those funds where you could earn a good return.
Keep in mind you can opt to just pay for part of the car using cash for a good compromise. For example, if you plan to finance, you might make a down payment of a few thousands of dollars and save on financing costs over time this way. This reduces the amount you need to borrow and may make it easier to qualify for financing too. However, you can even pay for half the car's cost or more with cash.
Buying a Car With Trade-in
If you own a vehicle and want to get rid of it when you get your new car, then you can use a vehicle trade-in as an alternative to a private sale to help offset some of the cost. Although this often leads to getting less money for your old vehicle than you would selling to potential buyers privately, it offers convenience. You can get an offer from the dealership before or after visiting, and then simply have the proceeds applied toward the total cost for your new car.
When deciding whether to trade in your car, you should be aware of some potential issues that can complicate the process. You shouldn't have issues if the car has a clean title, no remaining loan balance and still has some value left that makes it desirable to the dealership. However, things change when you still have a loan on the car, especially when there's negative equity involved where your loan balance exceeds your car's value. In this situation, you either have to pay the difference to the lender or allow the remaining amount to get rolled into a car loan you get for the new vehicle.
To make sure that doing a vehicle trade-in fits your situation, you can use the Kelley Blue Book website to see your car's value in its current condition, since this tool shows typical price ranges for both private party sales and dealership trade-ins. Then you can check on your car loan, if you have one, and come up with a strategy to handle the gap that can result if you're dealing with negative equity.
Read More: What Does a Car's Black Book Value Mean?
Buying a Car With Financing
Along with paying cash and doing a vehicle trade-in, you can finance the remainder of your car purchase costs and get a monthly payment amount that you can afford. With this option, you usually pay an interest rate based on the lender, your credit score, type of vehicle, manufacturer promotions and other factors. Your car loan might just last a few years or stretch as far as 84 months, with longer terms increasing the total interest due.
You can get vehicle financing through these three main routes:
- Direct financing: Going directly to banks and credit unions and getting preapproved for a vehicle loan can offer the best deal on interest rates as well as provide the chance to thoroughly research multiple offers before going to buy a car. For example, you can provide basic financial data online and quickly have an idea of your vehicle affordability and estimated payment. You can take your proof of preapproval to the dealership, where you work with the financial institution to finalize the loan application, and then complete the sale with the dealership. This option usually requires a good credit score.
- In-house financing: Usually used for buying used cars when you don't have good credit, in-house financing means that the dealership is the lender who decides your car affordability and interest rate. While this financing helps you get a vehicle in a tough situation, this option has the highest interest rates, and your vehicle selection is usually limited to used cars on the specific dealer's lot. It does, however, offer the convenience of a "buy here, pay here" experience, since everything from the application to monthly payments happen through the dealer.
- Dealer-arranged financing: Blending some aspects of direct and in-house financing, this method offers the convenience of applying for your car loan at the dealership and the benefit of likely getting better interest rates than you would with in-house financing. The dealership serves as the middleman by connecting you with lenders and getting offers. You can choose one and proceed with the car purchase. Interest rates usually go up slightly because the dealership adds a markup, and you usually need to have fair or good credit to qualify. After the purchase, you handle the loan through the associated financial institution and not the dealer.
Keep in mind that any lender needs proof you can afford the car loan. If you don't meet their criteria, you may have to lower your target car price range or increase the down payment amount. For example, you need sufficient income along with a suitable credit score for most auto loan options, and factors like your existing debt can lower your maximum loan amount. If you struggle to get suitable financing, you might have to find a co-signer to help you meet the requirements.
Read More: What Is Car Dealer Financing?
Starting the Vehicle Search
When you're buying a car with the goal of trading in your current vehicle, look for a dealership that offers both a reasonable price for car you want one and a decent offer for the car you're trading in. Once you have some possible next cars in mind, start researching prices through a source like Edmunds or Kelley Blue Book to see what the typical selling price is in your locale. Also look up your trade-in vehicle's market value. Then you can scan the inventories of dealerships to locate places that have cars you like.
If a car looks interesting to you, the next step is a quote request – which you can do online for your convenience. In your request, you include some contact information, any questions about the car and information about your desire to trade in your old car. You can include details such as the year, model, make, mileage and condition for your trade-in car so you can get a price quote that incorporates the estimated trade-in value.
For the best results, you might go through the quote process at a few dealerships. Feel free to negotiate both the trade-in offer and sale price of the new car online and over the phone to save some time at the dealership. Also, ask about current promotions such as rebates and financing offers that might apply. You can then set up a time to go to the dealership to proceed.
Preparing for Purchase and Trade-In
If you plan to just use your down payment and trade-in value and then finance the rest, you also need to decide on a type of financing and get needed documents in order. For example, start the preapproval process before going to the dealer if you're going with direct lending. With the dealer-arranged or in-house financing options, bring proof of your income, and check with the dealer to find out if other items like proof of residency or reference letters are needed. Cash buyers usually need to go to the bank for a certified check once they know the total price for the car minus the trade-in value.
You also need to have your old vehicle ready for the trade-in process. This means not only working on handling issues like negative equity but cleaning up the vehicle so that the dealership offers you the best price. For example, it can help to wash the car, make small repairs and vacuum the interior. Also, gather your car's papers, such as its maintenance records and title, since the dealership will want to see them.
Completing Car Buying and Trade-in Processes
When you get to the dealership, you can expect to examine and test drive the vehicle you want to buy as well as look around at alternative vehicles that interest you. Once you've found the right car, the dealership starts with the purchase process. They also examine, test drive and officially valuate your trade-in vehicle.
You'll make your down payment, get financing and present related documents and identification, as well as sign papers for things like the vehicle bill of sale, title transfer for the trade-in car and any financial forms.
Read More: The Best Time to Buy a New Car
- Federal Trade Commission: Buying a New Car
- Edmunds: How to Trade In a Car
- Federal Trade Commission: Auto Trade-Ins and Negative Equity
- My Credit Union: Buying a Car
- Federal Trade Commission: Financing or Leasing a Car
- Consumer Financial Protection Bureau: What Is the Difference Between Dealer-Arranged and Bank Financing?
- Consumer Financial Protection Bureau: Why Might I Need a Co-Signer in Order to Get Vehicle Financing?
- Auto Credit Express: How to Prepare Your Vehicle for the Trade-in Process
- Federal Trade Commission: Buying a Used Car
- My Credit Union: Leasing a Car: Getting Started
- American Family Insurance: What to Bring When Buying a Car From a Dealership
- Internal Revenue Service. "Topic No. 409 Capital Gains and Losses." Accessed May 8, 2020.
Ashley Donohoe has written about business and technology topics since 2010. Having a Master of Business Administration degree, bookkeeping certification and experience running a small business and doing tax returns, she is knowledgeable about the tax issues individuals and businesses face. Other places featuring her business writing include Zacks, JobHero, LoveToKnow, Bizfluent, Chron and Study.com.