The term, trade car, means to use the value of an existing car as credit toward the purchase or lease of a new car.

When a car is traded, a dealer buys that car from the owner and gives the owner credit for it’s value as a down payment on a new car — either a purchase or a lease. Since the dealer usually intends to sell the car on his used-car lot, he only offers wholesale price to the owner doing the trade. He then sells the car for retail price and makes a profit.

Although the trading process is convenient, car buying customers may be able to sell their old car to another individual for a higher price than a dealer would offer them for a trade. The money from the sale can then be used as a down payment on a new vehicle.

One advantage of trading (in most states) over outright sale is that a dealer will give sales tax credit for a trade vehicle, in addition to trade value credit. This reduces sales tax paid for the new vehicle. This should be considered when making a sell-versus-trade decision.

Can I trade cars if I still owe on my old loan?

If there is still an outstanding loan (“lien”) on the old vehicle, a trade becomes a bit more complicated.

If the balance on the loan is less than the trade value of the vehicle, a dealer will pay off that loan and apply only the difference as trade credit. If the balance is near the vehicle’s trade value, the trade makes little difference in the new-car transaction.

However, if the loan balance is more than the trade vehicle’s value, it is considered to be “upside down” and there is no trade value to apply as a down payment on a new car. In fact, quite the opposite. If a dealer accepts the trade, he will pay off the loan and add the difference (negative equity) to the price of the new car, making the new car more expensive than anticipated. If the negative equity is too great, the dealer may refuse the trade, or ask for a hefty cash down payment of offset some or all of the negative balance. Inexperienced buyers should understand what a dealer means when he promises to “pay off your old loan.” He’s not telling the entire story.