A customer walks in and wants to purchase a new vehicle. The customer has a trade-in she wants to include in the deal. Easy-peasy, right? Well, the hiccup is that the customer wants to retain some equity from the trade. Because this situation is a relative rarity in the dealer world (most customers will simply use all the trade-in equity as a downpayment on the new vehicle), some salespeople panic and do not correctly disclose this arrangement on the contract. Although much less of a rarity, we have been receiving a number of calls recently on the hotline regarding correctly disclosing negative trade equity on the contract as well. Accordingly, this article will be all about proper documentation of equity on the LAWCA-553 Retail Installment Sale Contract. We will first look at the more common negative equity situation.
Disclosure of Negative Equity
“Negative equity” occurs when there remains a prior credit or lease balance on the trade-in vehicle even after taking into account the value of the trade-in vehicle and any other downpayment amounts. When disclosing negative trade-in equity on a 553, there are three areas on the contract that require attention. Let’s examine each of these separately:
“Trade-In Vehicle(s)” Box Disclosure
Line 1a: This is used to indicate the agreed upon value of the trade-in vehicle. Remember that when valuing a trade-in, do not provide over-allowance to hide any potential negative equity. For an in-depth discussion about this and other trade-in best practices, please refer to our Taking Vehicles In on Tradearticle.
Line 1b: This is used to describe any amount of retained equity from the trade-in (more on that below). For the purposes of a negative equity situation, the customer cannot retain any equity, and thus there should be a “0” on this line.
Line 1c: This is used to state the amount of the agreed value of the trade-in that is being applied as a downpayment. In a negative equity situation, the amount on this line should be the same as the amount on line 1a.
Line 1d: This is used to indicate the amount of any prior credit or lease balance that exists on the trade-in vehicle (i.e., the remaining loan amount). In a negative equity situation, this amount will be greater than the amount listed on line 1c.
Line 1e: This is the net trade amount applied to the transaction and is obtained by subtracting the amount on line 1d from the amount on line 1c. This amount should be a negative number in a negative equity situation.
One should note that the Trade-In Vehicle(s) Box has space for two trade-in vehicles, and lines 2a, b, c, d, and e mimic lines 1a, b, c, d, and e.
At the bottom of the box, there are three additional lines.
- Total Agreed Value of Property Being Traded-In: If there are two trade-in vehicles, then the amount is obtained by adding together the amount on lines 1c and 2c. If there is only one trade, then this line should reflect the same amount as on line 1c.
- Total Prior Credit or Lease Balance: If there are two trades, then the amount on this line is the sum of the amounts on 1d and 2d. If there is only one trade, then this line should reflect the same amount as on line 1d.
- Total Net Trade-In: If there are two trades, then the amount on this line is the sum of the amounts on 1e and 2e. If there is only one trade, then this line should reflect the same amount as on line 1e.
Total Downpayment Disclosure
The next area of disclosure is in the Total Downpayment section, or section 6 on the 553.
- Line 6.A.: This is the agreed upon trade-in value for up to two vehicles. The value listed for each vehicle on this line must match the value provided in the Trade-In Vehicle Box on lines 1c and 2c. The total value disclosed on this line must match the value listed on the Total Agreed Value of Property Being Traded-In line in the Trade-In Vehicle(s) Box.
- Line 6.B.: This is the credit or lease balance of each trade-in vehicle. The value listed for each vehicle must match the value in the Trade-In Vehicle Box on lines 1d and 2d. The total value disclosed on this line must match the value listed on the Total Prior Credit or Lease Balance line in the Trade-In Vehicle(s) Box.
- Line 6.C.: This is the net trade-in value after the credit or lease balance is subtracted from the agreed trade-in value applied to the transaction. The value listed for each vehicle must match the value in the Trade-In Vehicle Box on lines 1e and 2e. The total value disclosed on this line must match the value listed on the Total Net Trade-in line in the Trade-In Vehicle(s) Box. Remember, in a negative equity situation, this would be a negative number.
As you well know, the Total Downpayment section should reflect the total of all downpayments (see below for a picture of the Total Downpayment section). If the net downpayment is negative (as would be the case here in a negative equity situation), the amount on line 6 should be listed as “0.”
Prior Credit or Lease Balance In Itemization of Amount Finance Disclosure
If the net downpayment number is negative (resulting from the above-mentioned downpayment calculation), the dealer must disclose this number as a positive number on line 1.J., which directly increases the amount financed on the contract. Again, line 1.J. should only be used if one or two vehicles are trade-in toward the purchase and net negative equity exists after accounting for other downpayment amounts. The name of the third party to which the payoff (or payoffs if two vehicles) is made must be indicated on the appropriate line for each vehicle.
Disclosure of Retained Equity
Although they sound similar, “retained equity” is very different from the negative equity situation discussed above. Retained equity occurs when the trade-in vehicle’s agreed-upon value is greater than any prior credit or lease balance on the vehicle (i.e., trade equity), and the customer does not want to apply the full amount of the trade equity towards the purchase of the new vehicle. Similarly, retained equity exists when the trade equity exceeds the value of the new vehicle.
“Trade-In Vehicle(s)” Box Disclosure
To disclose retained equity, we must first look again at the Trade-In Vehicle(s) Box (pictured above). First, the dealer must indicate the agreed-upon value of the trade-in vehicle on line 1a (or 2a). Remember, trade values above ACV must not be used if the buyer or co-buyer will retain equity. As discussed above, over-allowances should generally be avoided. This is especially critical in retained equity situations to avoid even the appearance of inflated trade values.
Then, the dealer must indicate on line 1b (or 2b) the amount of retained equity from the trade. Remember, a customer cannot retain equity in circumstances where negative equity exists or where negative equity would be created by the retention of equity. Then, the dealer must state the correct amount of the agreed upon value of the trade-in that is being applied as a downpayment on line 1c (or 2c). As discussed above, this is accomplished by subtracting the amount on line 1b from line 1a. The remainder of the Trade-In Vehicle(s) Box should be properly filled out according to the instructions.
Lines 6.A., 6.B., and 6.C. of the Total Downpayment section should also be filled out according to the instructions.
“Blank Box Instructions”
The manner in which the buyer or co-buyer will retain the trade equity must also be described in the Blank Box along with the recipient (i.e., the buyer or co-buyer trading in the vehicle), and the deadline for the dealer to make the payment. The deadline should be outside the 10-day rescission window in case the contract is cancelled. Here is some sample language for reference:
Retained trade equity disclosed on line [1.b. and/or 2.b.] of the Trade-In Vehicle(s) Box will be provided to [Buyer or Co-Buyer] in the form of a check to be mailed within 15 days after execution of this contract.
Entering this information in the Blank Box is a crucial step that is frequently forgotten by dealers. Doing so prevents any argument about who is being paid the retained equity and how it will be paid. Also, without any deadline stated in the Blank Box, the dealer must provide the retained equity payment immediately to the customer. Without this deadline, if the dealer is having trouble obtaining financing and exercises its 10-day rights, the dealer is placed in the precarious position of chasing after the retained equity payment that was already provided to the customer.
If you have any questions regarding this topic or any other situation that may arise in your sales or service departments, hotline clients are invited to contact us at (800) 785-2880 (then press “4” for hotline) or [email protected].