Nothing is worse than being in an accident that totals your beloved car. Except perhaps the shocking realization that you owe more on the loan than your insurance company is willing to pay!
Owing more on the loan or lease for a vehicle that it is worth is called being “upside down”. Thanks to rising automobile prices, longer loan terms, and zero down payments, most people are upside down on their current vehicle. The vehicle depreciates in value faster than you are paying it off.
The market value for your car depends on several things: year, make/model, mileage, condition and “the market”. The older it is and the more miles you have driven, the lower the value. If the car is dirty, has dents and scratches, has been in a prior accident or has not been maintained properly, it will be worth less than a more pristine counterpart.
The “market” for a particular type of vehicle will also affect its value. Some cars just hold their value better than others for quality and reliability or simply “desirability” reasons. Hondas, Toyotas and BMWs traditionally hold their values much better than their American counterparts. Vehicle values may also be affected by external market factors. For example, when high gas prices hit the roof, the market for large SUVs dropped like a rock. Consumers traded their gas-guzzlers for smaller, more fuel-efficient vehicles. As a result, the supply of Suburbans and Expeditions far exceeded the demand, and prices plummeted.
The realization that you are upside down is depressing enough when you go to trade in your vehicle, but still owing money after your car is totaled in an accident (especially if it wasn’t your fault) can be devastating. “But my insurance company has to pay to for my car - right!?!” Not exactly. Your insurance company must pay you what it feels is the current, fair market value of your vehicle based on year, make, model and mileage. They insured the vehicle itself. How you financed it, and how much you still owe on the loan, is your problem. Fortunately, there is a simple and relatively inexpensive solution – Gap Insurance.
Gap insurance is an endorsement to your personal automobile policy that “fills the gap” between the amount you owe on your loan or lease and the actual cash value settlement paid by your insurance company in the event of a total vehicle loss. For example, let’s say you total your 2 year old car that you originally financed for 72 months. Your insurance company generously gives you $15,000, but you still owe $19,500 on your loan. The gap insurance will pay the $4,500 difference, possibly less a small deductible.
Gap insurance has a relatively small, one-time cost and must be purchased at or close to the time you purchase your vehicle (usually within a week or two). It can be purchased whether you are financing a new or pre-owned car. Most leases today have gap insurance built into the lease, but be sure to confirm that with the dealer before you sign the lease papers. Gap insurance is offered by car dealers, online vendors and some insurance companies, and the price typically ranges from $400 - $700.
If you finance your new or pre-owned vehicle for more than 48 months and/or you do not make a significant down payment, then you need gap insurance. It’s a small price to pay for the amount of risk that it mitigates. And, for your peace of mind.