If you’ve ever purchased a new car, or taken out a loan for vehicle, you may have been offered – or even required – to have gap insurance. If you’re like most people, you already buy auto insurance, so you may be wondering why you would also need gap insurance. That’s exactly the question we will answer here. But first, let’s talk about negative equity.
Upside Down Car Loans Recently Hit An All-Time High
In just one year’s time, a new car’s value can drop by more than 20 percent according to Experian. Unfortunately, it continues to plummet by 10 percent or so each year after that. So, it’s no surprise that many people owe more on their auto loans than their vehicle is worth. Plus, they may have also financed the tax, license, registration and extended warranties in their loan as well, exacerbating the issue.
Owing more than what your car is worth is also known as having “negative equity” or as “being upside down on your car loan.”
As coronavirus surged in April 2020, Edmunds reported that negative equity on vehicles had hit an all-time high. At that time, 44 percent of new vehicle sales with a trade-in had negative equity compared to 33 percent a year earlier in 2019. The average amount of negative equity was $5,868.
One reason that negative equity occurs is long loan periods. According to LendingTree, the average auto loan length for new cars hit 69.7 months in February 2021. If you finance a vehicle for a longer period, you pay it off slower. Negative equity also occurs when you purchase a vehicle without a substantial down payment or trade-in – or worse yet, with negative equity on your trade-in. If you miss payments or use a “skip” coupon, or have a high interest rate, you can also get upside down.
When Negative Equity Matters
You may be wondering why negative equity even matters. If a lender is willing to give you a loan and you’re willing to pay for the loan, who cares if you owe more than the car is worth?
You’re right – it certainly doesn’t matter most of the time.
However, this gap between what you owe and what your car is worth can create a financial chasm if your car is totaled in an accident. When a total loss occurs and you need to be reimbursed by your auto insurer, negative equity raises its ugly head.
Case in point:
Let’s say you own a 2019 Honda CR-V. Last month, a massive tree fell on it, and it is irreparably damaged. The insurance adjuster determined it is a “total loss."
You still owe $40,321 on your auto loan, but the claims adjuster estimates the value to be $34,389.
You receive a check for $34,389. You use that money to pay down your auto loan, but even after giving the lender your entire insurance check, you still owe $5,932.
Now, you have a problem. You have to scrounge up $5,932 just to pay off the loan on a car you no longer have – plus, you don’t have any money left for a down payment on a new ride.
This scenario illustrates why you might need gap insurance.
So, what is gap insurance? It’s the protection for the difference between your vehicle’s worth and your auto loan amount. In this scenario, if your vehicle was totaled, gap insurance would potentially cover the $5,932 not covered by your auto insurance policy.
How Does Gap Insurance Work?
Gap insurance is typically a separate and highly customizable policy. You choose the amount of coverage you need based on your financial “gap.” Auto dealerships and private insurers offer gap insurance, so it’s easy to obtain when you buy a vehicle.
Filing a claim on your gap insurance is separate from your total loss claim on your home or auto. Since they’re two individual policies, you handle them separately. Many vehicle owners keep track of their vehicle’s value and drop gap insurance when they no longer have a financial hole to cover.
How Much Does Gap Insurance Cost?
As mentioned, auto dealerships frequently offer gap insurance; however, it can get pricey. Purchasing a plan from an insurance agency may be more affordable.
As with all insurance, the cost of gap insurance depends on how much coverage you need. Several elements impact the cost of gap insurance, including:
- Claim history
- The market value of home or vehicle
When Do You Need Gap Insurance?
Generally, you can only purchase gap insurance during the first three years after buying your vehicle. Some lenders or insurers will require gap insurance if…
- You don’t have a 20 percent down payment
- Your loan term is 60 months or longer
- You’re leasing the vehicle
If there’s a circumstance that makes it possible for you to owe more than the car is worth, gap insurance makes sense.
Keep in mind than you only need gap insurance for as long as you have negative equity. Once your car is worth more than you owe, you can cancel your gap insurance. So, while your auto insurance loan stretchs for 60 months, your gap insurance policy may only be needed for 24 months.
Do You Need Gap Insurance?
Many car owners need gap insurance. The following are a few questions to ask yourself to help you determine if you need this coverage:
- Is your loan higher than the market value of your vehicle?
- Was your down payment small or non-existent?
- Did your roll other costs (such as licensing) into your loan?
- Do you have a long loan term?
- Are you paying a high interest rate?
- Are there circumstances that could cause your vehicle to depreciate more rapidly (such as extremely high mileage or wear and tear)?
- Do you live in a high-risk area where the risk of total loss is higher than average?
If you potentially owe more on your car than it is worth, consider your options carefully. Gap insurance could be the solution you’re searching for.
Please contact a one of our brokers for assistance in finding the best coverage for your vehicle. We’re here to help with all your personal insurance needs!