Eddie On Everything

What does it mean to be “upside down” on a loan?

June 10, 2006 on 5:01 pm | In finance |

Q: What does it mean to be “upside down” on a loan? I keep hearing this term on talk radio shows. (Like Dave Ramsey.)

A: Usually used in the context of car loans, the term “upside down” means that the car is worth far less than the amount of money owed on the loan. For example, let’s say that you owe $15,000 on a car that is only worth $7,000 - in this case, you are “upside down” by $8,000.

Many car buyers end up upside down in auto loans because they buy more car than they can afford at terms that they should never accept. Car dealers are all to eager to dangle low-monthly payment options in front of an unsaavy car buyer, knowing that once he accepts, the dealership will make a killing as the customer proceeds to make years of interest only payments, never reaching the actual principal. Under these terms, it can take a decade or more to finally pay off a car loan.

Remember, it is almost always a mistake to agree to any auto loan with a term of more than 60 months. If you can’t afford to make the monthly payments on a 5 year loan, you can’t afford the car.

Exacerbating the situation is the fact that automobiles depreciate faster than you can say the word “boondoggle.” Most new cars lose half of their value in a short 18 months, leaving most anyone with a loan term of more than 36 months upside down fairly quickly.

If you are upside down on an auto loan, you’re not alone. A recent Money Magazine survey showed that nearly 30% of new car shoppers are upside down in their current car loans.

Getting out

Unfortunately, there isn’t a lot you can do to get yourself out of this situation, other than pay off the loan as quickly as possible. And remember next time you buy a car, if you can’t afford the monthly payments on a 5 (or better, 3) year loan, you can’t afford the car!

Like this story? Share with others on:
      del.icio.us    digg    reddit    furl
      

Technorati Tags
loan finance automotive banking