Vehicle Trade-Ins: Trusting a car dealer to pay off your loan can be risky business

Thinking about trading in a car that you still owe money on?  Think very carefully, because buying a car when you haven't paid off the loan on your current vehicle can put you in serious financial jeopardy.  Even if a dealership agrees in writing to pay off your existing loan, there is no guarantee that it will do so.  It might be a dishonest business, one that is having financial difficulties, or may even go out of business before paying off your note.  Regardless of the reason, if the dealership fails to pay off your loan, you are the one responsible to the lien holder.

As a result, you could end up with two loans to pay off and not enough funds to do so.  If you are unable to make your payments, your car could be repossessed.  What's more, defaulting on a loan can adversely affect your credit rating, making it hard for you to get a good interest rate on a future loan, mortgage, credit card or insurance policy.  You might even be denied for a loan altogether.  Even if the dealer does pay off the loan, if he delays making the payment to the bank, your credit rating could still be adversely affected.

Beyond these risks, the truth is that if you still owe money on your car, it's probably not in your financial interest to sell it right now anyway, especially if you owe more than the car is worth.  This is called being "upside down", and usually means that your new car loan amount will include your existing loan balance on top of the price of your new car.  Can you really afford all that?  Remember that it is almost always cheaper to repair a car than to replace it.  Therefore, the best thing to do from a financial standpoint is to pay off your existing car loan before you buy another car.

If, however, it is not feasible to delay buying a new car because of a safety issue, growing family or other reason, be sure that you purchase the vehicle from a dealer with an excellent reputation.  You can check a dealer's reputation with the Better Business Bureau.  Before sealing the deal on your new car purchase, make sure that the written contract includes a promise to pay off the lien on your trade-in.  Follow-up with your lien holder within 30 days to confirm that the dealership has, in fact, paid off the note.  But remember that these measures still do not guarantee that the dealer will pay off your loan.

What to do if a car dealer does not pay off the loan on your trade-in

The following suggestions from the Georgia Attorney General's Consumer Protection Division should not be construed as legal advice, nor is it a guarantee that you do have a claim or defense under federal law.

  • First, talk to a private attorney to determine how the law applies to your particular situation. You may have some recourse under what is known as the Federal Trade Commission’s “holder” rule, 16 CFR 433.
  • Next, contact the company that is financing your trade-in, and explain the circumstances, i.e. that the car you are financing with them should have been paid off by the dealership, and that the car is physically in the dealership’s possession.  Provide the finance company with any documentation to this effect (such as any contracts you have signed with the dealership), and be able to provide the street address and phone number of the dealership.  Ask them to work with you so that the situation does not negatively impact your credit, if, for instance, there are outstanding payments owed on the trade-in vehicle due to the dealership’s failure to make the pay-off.  Remember that you are still legally, contractually bound to make payments to the finance company on your trade-in, even though the dealership has taken possession of it.  You are also legally responsible to maintain insurance on the vehicle.
  • Look at the documents (again, such as any contracts) you have related to your transaction with the dealership.  You should see in this paperwork that your trade-in was included as part of your new-car purchase; this shows that the dealership promised to pay off your trade-in.  Also, pull any documents you may have received from the company that financed your trade-in that explain that you still owe money on the car, even after the supposed “trade-in”.
  • Provide legible copies of these documents to the company that is financing the new car that you bought from the dealership.  (Copies only – always keep possession of your original documents!)  Explain to your new lender that you were misled into entering a contract with the dealership, and that you only bought the new car because the dealer promised to pay off the trade-in.  Explain that you turned over possession of the vehicle and keys to the dealership on the date you bought the new car.  Under the holder rule, if the dealership arranged financing for the purchase of your new car, then the company financing the new car could be subject to any claims and defenses that you have against the dealership.  If the dealership has wrongfully failed to pay off your trade-in, which was part of the contract for the purchase of the new car, you can claim that the dealership’s failure to pay off the old car impacts the new debt.  You should talk with the new finance company about taking the new car back and canceling the contract that requires you to pay for that car or lowering the new debt to make up for what you still owe on the old vehicle (including any deficiency amount you may owe on the trade-in, if it has been repossessed from the dealership and sold by the old finance company).
  • Your paperwork from the dealership may not show that a trade-in was part of the deal.  There have been instances of dealerships verbally telling consumers that their trade-ins would be part of new-car purchases, but failing to put this language in consumer contracts.  In that case, explain to the company financing the new car that you were promised verbally that your trade-in would be paid off.  The federal rule explained above still applies, though your case may be harder to make to the new finance company.

As stated above, the best thing to do first is to consult a private attorney, who can assess the particular facts of your potential claim and provide you with individualized legal advice.  That attorney can contact the lenders on your behalf and make any legal arguments for you.  Whatever you do, you need to act quickly.  The problem will only get worse the longer that you wait.