What could make a bad car deal worse? A wreck that leaves you owing thousands on a car you don’t own anymore.
If you did everything wrong while acquiring your last vehicle, you may still be able to do at least one thing right. And that’s buying so-called “gap insurance.”
Gap insurance kicks in when the amount your insurer would pay for your totaled or stolen car falls short of what you still owe on the loan or lease.
Chances are good you need gap insurance if:
You purchased a new car and didn’t have a down payment of at least 20%.
You’re leasing a car.
You’re financing for more than four years.
You rolled debt from your last car into your current auto loan.
I outlined why these car-buying practices are usually bad ideas in “The real reason you’re broke.” They are, unfortunately, fairly common scenarios that typically leave people “upside down,” or owing more on their cars than the vehicles are worth.
Yet gap insurance remains a relatively unknown product, said Patrick Olsen, managing editor of Cars.com.
“As soon as you drive off the lot, depreciation kicks in,” Olsen said. “I don’t think people are aware of the danger they could be in.”
If you don’t make a 20% down payment, for example, you’ll be upside-down on the car from the minute you drive off the lot, and you’ll typically stay that way for two to three years, depending on the length of your loan. If you get in an accident or the car is stolen during that time, you may be in trouble.
Video: Should you buy or lease?
“The insurance company will pay you what the vehicle is (currently) worth, and that’s not necessary the same as what you owe,” said Mike Meredith, financial editor for MSN Autos. “It could be a lot less.”
You could be pushed over the edge
Here’s an example. You buy or lease a car for around $25,000. Several months down the road, it’s totaled, but your insurance check covers only the car’s current value, which is about $20,000. Not only do you have to find new wheels, but you’re on the hook to the finance or lease company for that $5,000 gap. It’s not uncommon for cars to lose two-thirds of their value in just three years. (See MSN Autos’ list of vehicles that hold their value best.)
If you rolled debt from your old loan into your new one, that amount you owe could be even larger. One out of four vehicles that are financed includes debt rolled over from a previous vehicle, according to vehicle research site Edmunds.com, and the average amount of so-called “negative equity” is more than $4,000.
If your finances are already shaky, the gap between what you owe and what you’re paid could be enough to push you right over the edge.
“It could be the difference between staying afloat and having to declare bankruptcy,” said Phil Reed, consumer advice editor for Edmunds.com and co-author of the book “Strategies for Smart Car Buyers.” At a minimum, you could be saddled with expensive and unwelcome debt.
If you’re not sure where you stand, you can use the Kelley Blue Book tool on MSN Autos to see how much your car is really worth and compare that to what you owe. Insurers typically pay an amount somewhere between the car’s trade-in value and what you’d get in a private sale.
Not to worry
Now, there are two scenarios where underwater drivers don’t have to worry about gap insurance:
If it’s already included in your lease. In some states, including New York, leases by law must include gap coverage, Olsen said.
If your auto policy is written to cover the gap. This isn’t the norm, but some auto policies promise to pay off a loan regardless of what the car’s worth. You can try reading your policy to see if you’re covered for any gaps, or simply call your insurer and ask.
If you don’t have coverage already, the solution fortunately doesn’t have to be that expensive. A premium of a few hundred dollars should cover you for the life of the loan or lease. You typically can buy the coverage:
From the dealershipor auto finance company. It’s probably the most expensive choice, especially if you roll the cost into your monthly note. You’ll be paying interest on it, plus paying for coverage even after you’re no longer upside-down on your loan.
From your current auto insurer. It’s usually the best choice, if your insurer offers the coverage. Farmers Insurance, for example, offers gap coverage at a flat rate of $25 every six months to Washington drivers. You can drop it once you’re sure you’re in the black.
From another insurance carrier. You can look for gap insurance providers; make sure they have top marks from one of the rating services such as A.M. Best, Standard & Poor’s or TheStreet.com Ratings (formerly Weiss Ratings).
The best time to shop for coverage is before you even set foot on the dealer’s lot, Reed said. He advises calling your insurer to get a quote for coverage as soon as you decide what car you’re going to buy. But all isn’t lost if you fail to plan that far ahead.
“It’ll be cheaper through your agent than through a dealership,” Reed said, “but you can always buy it (at the dealership) and cancel it later” once you’ve got coverage with your insurer.
Video: Should you buy or lease?
If you’re a savvy enough negotiator, you may be able to get the dealership to lower its premium, Meredith said, particularly if you already know what coverage would cost through your insurer.Some dealerships and insurers require you to get the coverage when you buy the car, but others let you add it later. If you don’t have gap coverage and need it, it’s worth the effort to search for a company that will sell it to you.
Like most insurance, it’s something you may never need, Meredith said, but “it’s a really good thing to have if you need it.
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