Trading in a car that's still financed

Trading a used car could be a real money trap for inexperienced consumers if the vehicle happens to be financed with a secured loan.

Buy a small SUV for $27,000 on the road and within a couple of years its trade-in value may have dropped as low as $13,000. And if you borrowed $20,000 to buy that SUV, at six per cent interest over a five-year period, the offer from the dealer may barely pay out the principle (or the amount owing on the loan).

So there you are, with a car that's cost you a $7000 deposit and over $9000 in monthly repayments. You're down the tubes over $16,000 and still have to borrow $17,000 for the $30,000 car you want to buy for your next car in 2019.

While the difference in purchase price for the two cars – two years apart – is only $3000, the interest payable, the depreciation and the consequent trade-in price essentially add up to $30,000 – a net loss of $16,000 on your used car and a net liability (for the new car) of $14,000 added together. And it will be more again, by the time you've also factored in the interest for the new vehicle.

It really pays to do your homework before you sell a car that's financed – and especially if you trade it in for a newer model. Bear in mind also that you may be called upon to pay an early cancellation fee for the loan.

But savage depreciation and high interest aren't the only things to consider when you trade in a financed car.

If the lender has a financial stake in your car you will need permission from the lender before you can sell it.

The car is 'security' (or collateral) and is actually owned in part by the lender. It cannot be sold (or traded-in) without repaying in full the lender's liability – the principal, or balance the consumer owes the financier.

Not only must the lender be notified of the sale, so must the vehicle's insurer, having noted the lender's financial interest in the old car. The insurer cannot cancel the comprehensive policy covering the car or transfer the cover to a different car until advised by the lender that the insurer is clear to do so.

A dealer, negotiating with you to trade your current car for a new one, will carry out 'due diligence' to check for any 'encumbrance' you may have neglected to mention, by checking the Personal Property Security Register (PPSR) or carsales.com.au service, CarFacts.

If there is an encumbrance – a lender's financial stake prohibiting sale of a car – the dealer could choose to withdraw the offer to trade your car for a new one.

The dealer may negotiate with you for a change-over price to trade in the current car on a new one, provided the finance is repaid. That may involve you, the borrower, renegotiating to pay out the balance owing for the current vehicle and making up the difference in asking price for the new one.

Working through a trade-in transaction when finance is key to the deal going ahead can get complex. You need to keep the lender in the loop and the dealer has to be on the ball too.

Whether you drive a renegotiated deal with your current lender or arrange a new loan with a different financial institution, the lender for the new car has to be satisfied that the financial interest is noted on a valid insurance certificate or cover note.

The lender will also need to be informed of the vehicle's unique details – make, model, series, vehicle identification number (VIN), registration number, expiry date and issuing state.

And the financial interest will be noted by registration authorities and will appear as an encumbrance on the PPSR.

The previous lender will get hot and bothered if the balance owed isn't paid out. So the new lender may have to make two payments – one to the dealer and one to pay out the previous finance contract.

In the good old days the buyer would arrange a bank cheque to cover the change-over price before taking delivery of the new vehicle. But in recent years electronic funds transfer has become the default method. The lender will need to know the dealer's ABN, business name, BSB and account number – the latter two items for direct credit transfer.

Financial institutions may choose to allow the customer up to around two weeks to supply the car's identification details and comply with all the pre-requisites, but not all lenders will necessarily be that accommodating, so it's important to check beforehand.

If it happens that you're trading the old car on one worth less, in market value terms, the lender will still need to be paid out, and the dealer will likely insist that money owing is paid before cars are swapped and keys handed over. This might be the case if or when you need cash in a hurry for an emergency.

The dealer won't want to take possession of a car that owes money to a third party. Instead, the dealer may arrange a deal paying the vehicle owner a net sum, with the loan principal deducted and paid directly to the financier.

Glossary:
Vendor – the person selling the car
Lender – bank or other financial institution with a stake in the property (the car)
Collateral – the lender's financial interest in the property (the car)
Secured loan – hire purchase, novated lease or other type of loan that requires collateral
Default – the owner of the vehicle ceases to pay off the loan
Encumbrance – the lender's stake in the car, registered on PPSR
Repossession – legal acquisition of the vehicle by the lender when the owner is in default

At a glance

DISCLAIMER: The information contained in this document is general in nature and should not be relied upon as legal advice. carsales does not warrant the accuracy or completeness of any representations made in the document or that the material is suitable for any purpose. You are responsible for assessing the material and seeking your own legal or financial advice. To the fullest extent permitted by law, carsales excludes all liability for loss or damage (including indirect or consequential loss or damage) which may be incurred in connection with your use of or reliance on the material contained in this document.