Many consumers decide to trade-in their cars before they have paid off the old loan. When things go right, the dealership will obtain a pay-off amount from the bank or finance company and will make the payment on time and for the proper amount. The dealer gets the title, and the old car loan is paid off.
Although the dealership makes the payment to the bank or finance company, ultimately, consumers pay the bill. For example, if the trade-in is worth $12,000 and the balance owed on the old loan is $10,000, then the consumer is credited with only the $2,000 difference. The equity on the trade-in was utilized to pay the loan balance.
By contrast, if the trade-in is "upside down" ( a term used by dealerships to describe situations where the loan balance is more than the car's value), things are more complicated. If the trade-in is worth $12,000 and the loan balance is $14,000, the $2,000 shortfall is going to have to be made up somewhere. Under federal lending laws, the dealership is supposed to add the add the $2,000 difference to the new loan amount, in which case the consumer pays that shortfall over the course of the new loan term. In many cases, dealerships violate the law by charging more money for the new car or by forcing the consumer to purchase various "extras" to make up the difference. Either way, the consumer pays the bill, plus interest.
Most of the time, consumers don't give much thought to the old car loan. They simply drive off in their new car, thinking that the dealership has taken care of everything. Significant problems arise, however, when a dealership doesn't pay off the loan or when it plays games with the timing or the amount of the pay-off. Although consumers may not realize it, they remain responsible for the old car loan, and there can be significant consequences and costs to the consumer if the dealership doesn't make prompt payment for the correct amount.
One problem is that sometimes dealership do not make the payment until well after the new car purchase. If there are additional interest charges or late fees, the dealership should be responsible to pay those extra costs. But, if the delay is long enough, it could hurt a consumer's credit. It is a good idea to keep an eye on the old loan and make sure that it is paid off before payments become past-due. It is especially important to make sure that payment is made before a payment is 30-days late, because late payments can cause significant credit harm.
Consumers can avoid credit harm by not trading a car in shortly before a payment due date. If you are shopping for a car on the 5th of the month and your payment is due on the 10th, go ahead and make the next payment a little early. You will still get credit for the extra payment, because it will pay down the loan balance, so more of the car's equity will be applied to the new purchase.
Consumers can also avoid credit harm by continuing to monitor their old account after the new car purchase. If the payment is not credited to the account within a week or so, then the dealership should be questioned. And, if it looks like a payment is going to be late - especially if it is going to be 30 day slate - then consider making a payment on the old loan. You'll eventually get the money back when the dealership finally makes the payment, because the bank will be responsible to refund the surplus payment to the consumer.
Another problem is that sometimes a dealership will play games with the pay-off amount. For example, if there is a balance of $10,000 on the trade-in and there is interest being charged at the rate of $3.00/day, the dealership might put a balance owed of $10,084 on the paperwork. That effectively gives the dealership a four week loan for $10,000 - and the interest is being paid by the consumer! Another dealership game is to put a higher pay-off on the loan then the amount really owed. This is a direct theft of money from the consumer! Both scenarios are sneaky ways to boost dealer profits at the consumer's expense, and they are highly deceptive and against the law. The best way for consumers to protect themselves is to request a payoff from the finance company BEFORE going to the dealership and make sure that the payoff on their contract documents is correct.
So, consumers can protect themselves from dealership games by confirming the loan pay-off directly with the bank or finance company and closely monitoring their account to confirm that payments are made on time. But, there is a far more serious problem that some consumers face, and that is the failure by the dealership to ever pay off the loan balance. I was recently interviewed about this topic in an article on Consumer Reports website.
If a dealership never pays off the trade-in, the consumer has a serious problem. They may get sued by the bank or finance company, and their credit will suffer serious harm. Usually, a dealership that does not pay off trades is in serious financial trouble, and it could be a sign that the dealership may go out of business. This is a very serious problem, and any consumer facing it should consult with an experienced consumer law attorney as soon as possible. Most consumer attorneys will give a free case assessment.