The fact alone that you want to trade in a car does not affect whether or not a loan on a new car purchase will be approved or declined. However, the financial status of your trade-in may have either a negative or positive effect on how the lender views your loan application.
Auto Lender Criteria
The lender for an auto loan reviews several factors when evaluating whether or not to approve financing for someone who wants to buy a car. The buyer's credit history is evaluated using factors such as a credit score/past credit history and the amounts previously borrowed compared with the size of the requested car loan. In addition, the requested loan-to-value ratio compares the size of the loan with the price of the car, using the manufacturer's suggested retail price for new cars and wholesale Kelley Blue Book for used. All other factors being equal, a lender is more likely to approve a loan that is 80 percent of the price of a car compared with a loan asking for funds equal to 105 percent of the value.
Status of Current Car Loan
If you have a loan on the car you are trading in, how well you kept up on the payments on that loan will affect how the lender looks at the new application for auto financing. If you have had the loan for a year or longer and have been on time with all of the payments, that is a plus in your favor with the new lender. At the opposite extreme, if you are behind on the payments for the car you want to trade, it is very unlikely that any lender will approve you for a new car loan. When financing car purchases, a good payment history is the best way to allow yourself to regularly trade up to a new car.
Trade With Equity
If the car you want to trade in is worth more than the outstanding loan balance, or you do not have any loan on the car, the positive equity in your trade-in will be a plus toward getting approved for a new car loan. To a lender, positive equity has the same value as putting up cash as a down payment toward the new vehicle. Cash down results in a lower loan-to-value and a higher chance of being approved and also paying a lower interest rate on the loan.
If you owe more on your car than it is worth as a trade-in, you are what is described as "upside-down," with negative equity in the vehicle you want to trade. To trade in the car, the amount you are upside down has to go somewhere. A buyer with good credit may be able to roll or transfer some or all of the negative equity into a loan on the new car. The result will be a larger loan amount and bigger payment than if the new car were bought without the trade-in. Rolling negative equity means a bigger loan and less equity. Both are factors that can reduce your chance of getting an approval on the new loan.
- FTC: Understanding Vehicle Financing
- Bankrate: Sizing Up Your Down Payment
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Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.