Should I sell my car before it depreciates?
Is It a Good Idea to Trade in Your Car Before It Is Paid Off?
Thomas J. Brock is a CFA and CPA with more than 20 years of experience in various areas including investing, insurance portfolio management, finance and accounting, personal investment and financial planning advice, and development of educational materials about life insurance and annuities.
In This Article
In This Article
You are nearing the end of your car loan, and you’re wondering if you should trade in your vehicle for a new one before the loan is paid off. Should you wait until you have done so, or is it a good idea to go ahead and trade it in for a new car whenever you find a vehicle that you like?
As with most large financial decisions in life, the answer is complicated—but we’re here to help make it easier.
A Car Is a Depreciating Asset
Before you decide whether or not to trade in your vehicle, you should understand that it is a depreciating asset which means that, unlike a house or a stock, it only decreases in value the longer you own it.
According to data from Carfax, a car depreciates about 10% of its value in the first month, 20% in the first year, and about 10% more of its value each year after that. That means your pristine $30,000 vehicle purchased in June will be worth about $27,000 in July, and $24,000 come next June.
If you have a loan on your vehicle and your car has decreased in value, you may find yourself in a situation in which you owe more on the car loan than the car is worth at any given point. If you put less than 20% down on your vehicle, this is very likely to happen to you within the first year. This will put you in a position of having negative equity, or owe more on your loan than you have in equity, which is equal to the value of your asset (in this case, your car).
If you trade in your vehicle when you have negative equity, this will put you in a position where the collateral you used to secure your loan—your car—is no longer in your possession. This will mean that you will owe the full remaining value of your loan as soon as you trade in your vehicle for a new one.
If you are not able to pay off the remainder of this loan, it will end up getting added to the amount of the new loan on your new vehicle. This will either make your new loan longer or your payments larger than they would have been if you had waited until you paid off your vehicle before trading it in for a new one.
When Is It a Good Idea to Trade In?
It’s a good idea to trade in your vehicle when you own a gas guzzler. If you own a vehicle that requires a lot of fuel, you could save a lot of money in the long-run by trading it in for a car that gets better gas mileage, especially if you drive a lot as a part of your regular routine. Make sure that you crunch the numbers, though. If you pick a pricier car, you might not save money even if it has better fuel efficiency.
You could also trade in your vehicle when the dealer credit is actually a good idea. If you only owe $3,000 on your loan and your dealer offers a $2,000 sign-over bonus, it may actually be a good financial move to trade in your new vehicle rather than paying off the remaining $3,000 over the course of several months.
When You Should Wait to Trade In
It is best not to trade in your vehicle when you purchased it very recently. As soon as you drive a new vehicle off the lot, it loses around 10% of its value and up to 20% of its value within the first year. If you purchased a new, not used, vehicle within the last year and are thinking of trading it in, just don’t. Whatever exciting deal or sweet ride you recently encountered can wait. It’s not worth wrecking your financial future for a newer set of wheels.
You should also wait to trade in when you have prepayment penalties. When a lender agrees to a car loan, they are counting on earning interest off of you for a set amount of time. When you pay off a loan early, you are depriving the lender of this income—and because of this, you will likely pay a prepayment penalty in most cases if you pay off the loan early.
You should also wait when time is on your side. If you own a newer car, you can always trade it in later or sell it to another private party, which would generally mean you would make more money off of the transaction.
If You Do Decide to Trade In Your Vehicle
Make sure you understand and get in writing, exactly what you are going to be getting from the dealership when you purchase your new car. Make sure to ask, and pay special attention to, how your new loan will treat negative equity. It will definitely be easy to find a dealer who will finance your purchase, but the more important question will be whether or not it is truly worth it for you.
Frequently Asked Questions (FAQs)
How soon can you trade in a financed car?
You can trade in a financed car at any time. It may not make financial sense to trade in a vehicle right after you’ve purchased it because of depreciation. Depending on the size of your down payment and the length of your loan, you’ll usually want to wait at least one year, and ideally at least three, before trading in your vehicle. Looking up your vehicle’s trade-in value can help you decide on the best time to trade it in.
How do you trade in a car that’s not paid off?
To trade in a car that’s not paid off, you’ll need to visit a dealership with your loan information, vehicle information, and proof of insurance. You may want to visit more than one dealership to compare offers. Be prepared to negotiate, as the price of the new car and the value of your current one are negotiable. If you have negative equity on your current vehicle, which means you owe more than your vehicle is worth, be cautious about rolling your negative equity into a new loan. Be sure the numbers make sense.
Score a Great Deal on a Used Car by Understanding Depreciation
- Compare lease prices
- Ample supply reduces depreciated-valuation
Finding a great deal on a used vehicle requires strategy. You can spend hours scouring local dealerships or online used-car listings, and with a bit of finagling, you might negotiate a bargain price. But empowering yourself with insight on car depreciation and how it affects the cost of a pre-owned vehicle can ensure that you maximize the amount of car, truck, or SUV you get for your money.
What is depreciation? In a nutshell, it’s the value that a vehicle loses with time and use. With rare exceptions for collectible cars, most new vehicles begin to depreciate the minute they are driven off a dealership lot. Those vehicles usually continue to lose value until they hit a price floor when they’re worth more as scrap metal than as transportation.
Here’s the key to using depreciation to your advantage: Not all vehicles depreciate at the same rate. Consider two compact SUVs from different brands: Both offer similar features and sell for $40,000 when new, yet three years later, with the same mileage and in similar condition, they might sell as used vehicles with thousands of dollars difference between their prices. A vehicle with high depreciation eventually becomes a cheaper used vehicle.
When new, these two cars were valued the same, yet now buyers and sellers seem to think one is worth more. What changed? In some cases, a vehicle’s long-term reliability or lack thereof drives how slowly or quickly it depreciates. In other cases, the price difference largely amounts to perception. Is the vehicle cool, or in demand, or hard to find? These cars will likely have low depreciation, and finding a deal will be harder. Has the styling aged poorly, or is the technology behind what its peers offered? These may drive down the price of the car without impacting its value to you, depending on your priorities.
Now comes the hard part of using depreciation as a bargain-hunting tactic: Finding data on depreciation for specific models can be challenging. It’s much easier to find vehicles with low depreciation (often referred to by the flip side of the same coin with the term “high residual value”). You can perform an internet search to find vehicles and brands with the highest residual values, which you should steer clear of if you’re looking for the best possible deal and assuming you will own this vehicle for several years. The following tips will help you sort out vehicles that may have high depreciation and offer a better opportunity as a used-car bargain.
Look at Lease Prices
When you lease, your monthly payments cover the depreciation (plus profit for the dealer and automaker) while you drive a car. If you scan advertised deals, you’ll find that some brands regularly charge higher lease prices than their competitors. A high lease price compared to vehicles in the same class is one clue that a used version of the same model may have high depreciation. The customer who leases that vehicle when new is, in essence, paying more to lower the price by a bigger margin for the whoever buys the car as a used vehicle.
Pay Attention to the Rental Lots
The next time you’re picking up a rental car at the airport, scan the lot and make a mental note of the most common vehicles. Rental companies buy cars at steep discounts, and automakers tend to unload their less popular models on these bulk buyers. When rental companies sell off their fleets, they flood the market with these models, all but guaranteeing there’s more supply than demand. This drives down the prices of all examples of a given model, even those bought by individuals at full price.
Luxury Loses Value Fast
As a general rule and speaking in percentages (rather than dollar figures), luxury cars tend to depreciate quicker than mainstream brands. At a certain point in the depreciation curve, it’s not uncommon for a used luxury car to be worth less than a similarly aged car from a proletarian brand.
“Luxury buyers want to be seen in the latest version of their preferred model, but that status fades quickly after a luxury vehicle drives off the lot, drastically reducing these models’ value on the secondary market,” says iSeeCars Executive Analyst Karl Brauer. “The price has to significantly drop to make these vehicles desirable to used car shoppers to compensate for their high operating costs and outdated technology.”
Just be aware that maintenance and repair prices can be significantly higher with a luxury vehicle than they are with mainstream brands, especially if you plan to service the vehicle at the dealership.
Sales Volume Skews Things
Sometimes popularity means there is immense demand for a vehicle that will persist for years. Other times it guarantees that the used-car market will be oversaturated with off-lease and three- to five-year-old cars. Consider full-size pickup trucks. In 2016, the Ram 1500 outsold the Toyota Tundra four-to-one. The ample supply of used Rams is one of the factors that drives the price down quicker than a used Tundra. A 2016 Ram 1500 loses 35.2% of its value over five years, according to the automotive research firm, iSeeCars. By comparison, a comparable 2016 Toyota Tundra pickup has a lower average five-year depreciation rate of 19.5%.
The Tundra’s high resale prices are helped by Toyota’s sterling reputation for quality. Of course, you don’t want to buy a vehicle that’s going to break down on you, regardless of price. In this case, you need to determine if a vehicle’s depreciation is driven because of actual low quality, or merely because of perception. Hyundai and Kia make consistently reliable vehicles, yet they don’t enjoy the same image as Toyota or Honda.
Vehicles with unique features, styling, or capabilities that increase their desirability naturally have higher prices on the used market. For example, the Jeep Wrangler has the lowest five-year depreciation of any 2016 model year vehicle at 9.2%, notes Nick Woolard, lead analyst for the consumer car insight source, TrueCar.
Depreciation During the Chip Shortage
In normal times, most cars will be worth less than its original value when it’s resold as a used vehicle, even if it only has few hundred miles on the odometer. But we’re not living in normal times. Due to supply-chain hiccups and a shortage of semiconductors chips, demand for cars—both pre-owned and new—currently outstrips supply. This has driven prices to an all-time high, even though the vehicles continue to age. In fact, in some extreme cases, used vehicles are now worth more than the manufacturer’s suggested price for a factory-fresh version, because new cars are so hard to find.
Still, the basic idea of depreciation still holds true. Vehicles that previously lost value quickly are still going to offer the best deals even when the car market is in a flux. And once new car production meets demand or exceeds it, used car prices should stabilize or even resume their usual downward trajectory. Nick Woolard, lead analyst for the consumer car insight source, TrueCar, sums it up best. “Things will stabilize, and a lot of that’s going to be predicated on new vehicle production coming back in a way that can fulfill the demand that’s out there, but It could be relatively near term; it could be long term,” explains Woolard. “But eventually we will be back to an environment where vehicles depreciate, like they historically have.”
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Marcus Amick has more than 20 years of journalism experience covering the world of automobiles, transportation, and mobility. The native Midwesterner—who now splits his time between Los Angeles and the Metro Detroit area—has written for a number of national automotive industry and consumer media outlets. Marcus also consults in the automotive sector, providing insight on lifestyle trends and how consumers connect with vehicles beyond the sheet metal.