I am “upside down on my mortgage” is a common phrase.
But what does it mean?
In short, it means that you owe more than the value of the property.
Upside Down Loan Illustrated
Unfortunately, assets tend to swing in value depending on market forces and macroeconomic activity. Houses are notorious for this. Imagine you bought a house or condo (if you live in New York like me and can’t afford a house) at a value of $500K.
But then, out of the blue, your neighborhood is no longer the “it” place to live. As a result, the demand for houses in your neighborhood decreases. These houses on the market take longer to get sold, and causes the supply to increase. A year later your house is appraised at $250K.
A 50% drop is rare but it could happen!
So now you are paying down a $500K house that is worth only $250K on the real estate market.
Depreciation and Car Loans
Unfortunately, being “upside down” does not only impact mortgage loans, they impact car loans too. The minute a new car rolls off the lot it depreciates in value. Depreciation is defined as “the reduction in value of an asset with the passage of time, due to particular wear and tear”. When it comes to cars, time is a key factor in rate of depreciation. It is widely known that after five years the car has lost around 50% in value. Other factors that impact the depreciation rate are:
- Desirability on the market
- Gas prices
You see the pattern here. When you couple the depreciation with 4, 5 and even 6-year loans, you get an upside down car loan.
Cars don’t get upside down by accident
Most of us probably are not buying a house anytime soon, but I would guess that many of us either have a car note or are planning to take out a loan to buy a car in the future. Cars don’t get upside down by accident.
- Depreciation (reduction in value of an asset)
- Overpaying for a car
- Getting “too much car”
- Adding options to the car that does not increase its value (only its purchase price)
- Stretching out the loan in order to decrease monthly payments
- Rolling over another car loan onto a new one (because you want that new car now)
Here are my thoughts:
- Buy used to reduce the depreciation impact
- Bring a friend along who is good with cars to help you assess the value of the desired car (so you don’t get cheated)
- Only buy enough car for what you need, not for what you want
- Again, only get options you will use
- Save up for a big down payment, to reduce length and month amount of loan
- Please, don’t do this
Have you ever been upside down on a loan? What did you do? Let me know in the comments.