Buying or Trading in a Used car? Ensure the Loan is Paid Off

If you're trading in a used car on which you still owe money, it can be convenient to have the car dealer take care of paying off your old loan, as many car buyers do. But it also can be dangerous. And so can buying a used car without making sure any outstanding loan has been discharged. A recent case by the New York attorney general shows why.

The state recently obtained a $339,000 judgment against a Rochester area used-car dealer that the attorney general accused of selling used cars that had remaining loan balances. The dealer was required to pay $289,000 in restitution to 46 consumers, and $50,000 in fines and other costs to New York State.

We've seen this many times before. Here's how it can happen. As part of a new car sale, a dealer agrees to pay off the customer's loan on an existing car, using the vehicle's trade-in value and possibly additional money obtained by increasing the loan amount for the new car. But instead, the dealer sells the used car with the loan instact, issuing the new owner a temporary registration (since states won't register a vehicle in a new owner's name until the debt is paid). Sometimes this occurs because the dealer is in financial trouble and decides to use the money to continue its operations. In other cases, the dealer goes belly-up before the loans are satisfied.

"It usually happens when a dealership is starting to fail financially," Daniel Blinn, managing partner of the Rocky Hill, Conn-based Consumer Law Group, said. Blinn has represented consumers in both scenarios, those who have been victimized when trading in a car with an outstanding loan or buying one.

In such cases, those who trade in their cars find out to their horror that they still owe money on the old loan, as well as on the one for the new vehicle. Those who buy the cars discover they can't register them, even though they too probably now have a loan obligation for the very same vehicle. This is exactly what the attorney general said happened in the New York case, and it's not the first time. For instance, the Illinois attorney general brought a similar case against a dealership in 2009. Consumer officials in Georgia and Michigan have issued warnings about this problem and offered advice on how to avoid it.

Looking for a new ride? Check out our new and used car buying guides.

What to do

If you're trading in a car. The best advice is to keep that car at least until you finish those loan payments, maintaining it according to the manufacturer's recommendations. Not only will you avoid this problem, but it's a much wiser move financially. Alternatively, sell the car privately and pay the loan off yourself, as the Consumer Federation of America advises in its brochure "How to Avoid Auto Fraud" (PDF). On the plus side, you'll probably get more for the vehicle. The downside is that it's a hassle and you won't get the sales tax break that many states give those who trade in a vehicle. Still, that pales compared to having your bank tell you that you still owe thousands on a car you no longer have. Even if the dealer does pay off your loan, it might be slow to act, potentially damaging your credit.

If you really must rely on the dealer to pay off the loan, make sure you have a written agreement. It should specify that the dealer will pay off the note immediately, instead of continuing to make payments. Verify with the lender that the loan has been repaid.

If you're buying a used car from a dealer. Ask to see the paperwork, including the title or a document, such as a lien release, showing that any loan has been satisfied. Try to avoid accepting a temporary registration, which shouldn't be a problem if you're transferring the registration on your existing car.

If you're defrauded. File a complaint with your state consumer agency. Some states have special funds to reimburse consumers who have been victimized by car dealers. Also consider contacting an attorney specializing in consumer law. If the dealer that engaged in this practice also arranged the loan on the new or used car it sold you, the finance company also may be responsible for your monetary damages, Blinn says.

—Anthony Giorgianni