Since the depreciation on motorcycles is so enormous after they’re taken off the showroom floor, the potential for a buyer to owe more on their motorcycle loan than on the bike is worth quite high. Owing more on your bike than it’s worth is often referred to as the “upside down” world.
Many people in this situation find that financial lessons are sometimes the most difficult and costly to learn. Motorcycle loans longer than 48 months (especially with no down payment) put you in the position of owing more than the value of the bike.
Let’s take a look at this phenomenon.
First, the interest calculation your lender uses can make a big difference in your situation, especially in the first 18 months. There are two primary interest calculations, precalculated (combined with the rule of 78) and simple interest.
Pre-calculated interest combined with the Rule of 78 is often the worst situation for a buyer because most of the interest is paid in the first 24 months. Therefore, in the first 24 months, little of the monthly payment has been used to pay the principal. If a buyer wishes to sell or trade in the motorcycle within this time period, it is likely that he will owe more than the motorcycle is worth. Statistics show that the average owner trades every 18-24 months.
Simple interest, on the other hand, is much more favorable to buyers since it increases the interest on the loan balance. However, buyers who extend their loans beyond 48 months may still find themselves upside down with simple interest. This is especially true if a down payment is not made. The reason this occurs is that the motorcycle depreciates faster than the principal is paid; leaving the balance owed to the lender for more than the bike can be sold.
A common opinion held by many people is that they will simply turn their motorcycle over to the lender if they are caught in an “upside down” position. If you are considering this option, don’t do it! Your worries don’t end only after your bike is delivered or retrieved; in fact, they are just beginning. The lender will sell your bike at auction for much less than it’s worth. You will still owe the difference between the amount you owe on your loan and the amount the motorcycle sold for at auction. So if you owe $5,000 and the bike sells for $1,500, you are still responsible for owing $3,500 to the lender. To make matters worse, lenders can add high auction fees that you will also have to pay. So the net result is that you are now responsible for making the monthly payments on a bike you can no longer use.
So what steps can you take to avoid getting caught “upside down”?
1. Find a lender that uses simple interest. Avoid lenders who use pre-calculated interest calculations / Rule of 78.
2. Always try to put money into your purchase.
3. Try to avoid motorcycle loans that extend beyond 36 months.