Are you going to take a loan? Make sure that it won’t turn your comfortable financial world upside down. According to statistics, nowadays up to 40% of consumers owe more on their car or home than it is worth. These types of loans are called “upside down.” They can bring you into financial trouble and hamper your successful future.

Most of us have met with upside loans in our life. Without an improving economic situation or loan modifications, the problem will become more widespread. Read more about the ways to avoid frivolous purchases and end up with the money in your pocket!

How loans get upside down

An upside down loan means that the item you bought loses its value faster than the loan balance decreases. This is a sad result of purchasing a depreciating item, for example a brand new car or a house in a bad location.

For example, imagine that you bought a new car for $30,000. One year later your car costs $25,000, two years later – just $18,000.  If you owe your creditor more than this amount, it means that you have an upside down loan. With no savings to pay the debt there isn’t much choice other than to keep the vehicle and make monthly payments.

There have always been consumers with upside down loans, but their number has grown up over the last several years. In today’s uncertain economic climate everything is depreciating very fast. The subprime mortgage crisis starting in 2007 and the following recession are still bringing borrowers down.

Avoiding an upside down loan

Most things in our life are not supposed to be upside down, including loans. People who took their mortgages 5-7 years ago might have expected their houses to increase in value over time, but the falling home prices ruined their plans.
If you find yourself with an upside down loan or you want to avoid one, pay attention to the following tips:
•    Consider short-term loans. Longer financing terms can make your monthly payments lower, but it will increase the total amount of the interest paid. Just compare: nowadays, the average APR for a 36 month new car loan is 6.91%, for a 48 month new car loan - 7.27. The average APR for mortgages is 2.5% for 3 years, 2.75% for 5 years, 3.5% for 7 years, 3.75% for 15 years and 4.25% for 30 years. So choose the shortest term that you can afford and try to cover your debt faster than your asset loses its value.
•    Don't skimp on the down payment. Most car buyers purchase a car by making a down payment (in cash or with trade-in) and then paying off the remaining balance. A large down payment (over 20%) will let you lower your balance and cut down the borrowing costs. If you are going to trade in your existing car, visit Kelly Bluebook or similar websites to estimate its value.
•    Avoid minimum monthly payment. A lot of borrowers dig themselves into a financial hole by making a low monthly payment. It could take years to pay off your remaining balance in full!  Do you think that your new expensive car will have the same value in 10 years?
•    Keep your credit report in the best shape. The better your credit score, the more favorable terms you will get. For example, if you have over 760 points, you can get 6.5% - 7% APR. A person with 630-669 points can rely on 11%. So want to get the best deal? Improve your credit score!
•    Consider buying GAP insurance. Gap insurance covers the difference between what the vehicle is worth and the current outstanding balance on your loan. If your car is stolen or totaled by accident, theft, vandalism, fire, flood, tornado, or hurricanes your insurance company will cover the difference.
•    Avoid depreciating assets. Do you know that a new car is worth approximately 30%-40% less in two years than the day it was purchased? That’s why it makes sense to buy a used vehicle or a car that you are going to use for a long time. If you are planning to buy a house, find out which ones hold value in a recession, and why. Good location and certain upgrades can help you make your house recession-proof.

Don’t let falling prices ruin your budget! By approaching the upside down loan monster from this angle, you can end up with an item that won’t depreciate in future and make most of your money.