Closing the Gap When Your Car Is Worth Less Than You Owe

Closing the Gap When Your Car Is Worth Less Than You Owe

You probably know that the minute you drive your new car off the dealer’s lot, it loses a significant portion of its value.  If you intend to keep it for at least a couple of years, to get to that break-even point and then sell it, the loss of value may not bother you. 

That loss of value would bother you more, though, if the nearby river overflowed and your new car floated way with everything else that wasn’t bolted down.  You might still owe $20,000 on it.  However, your insurance carrier might cover it for current value and send you a check for only $14,000.  You would end up owing the bank or finance company $6,000 and have no car to show for it. 

Unfortunately, that’s not the worst news.  These days, the big discounts being offered for new car purchases are depressing the value of slightly used cars even more.   That means, in auto industry parlance, that new car buyers who finance their new cars are even more  ‘upside down’ than ever before.  Lately, the average gap between what a car is worth and what is owed on it is $2,200.

In addition to discounting widening the gap, other factors, too, are putting new car buyers in the financial hole.  One of these is the buyer’s tendency to look for longer terms and lower payments.  But the longer it takes to pay for the car, the longer it takes to reach the point at which you owe less than the car’s depreciating value.  Another is the finance industry’s desire to accommodate these buyers, not to mention gain more interest.  In California, some dealers are writing seven-year finance contracts.  (Many people recall when three-year loans were standard, four-year unusual and five-year unheard of. These days, five-year loans are common.)

Dan Kiley, reporting in USA Today, noted that Friendly Chevrolet in Dallas estimates that 90% of its customers are upside-down, often owing as much as $10,000 to $15,000 more than the car is worth at trade-in time.

Gap insurance can fix that.  Some gap insurance policies can also be worthwhile if you simply want to trade the car in during its ‘upside down’ period.

Dealers, becoming more aware of the problems these widening gaps can cause, are beginning to offer gap insurance, usually costing between $500 and $700.  But, some manufacturers, including Honda and Toyota, discount so infrequently that they find only 15% of their customers-versus 90% for some big discounters-are ‘upside down’ and may not offer gap insurance at the dealership. And, in any case, dealer gap insurance may not be as comprehensive as the gap insurance you can find through an agent.

If you finance through a bank or credit union rather than the dealer’s finance company, you probably will not be offered gap insurance, either.  In fact, you may not be able to purchase it through the bank or credit union at all.  Again, the best bet is to check with an agent, who can not only find you the best policy for your situation, but help you assess whether you need it, or would be better off directing those insurance dollars to a more immediate need. And it is likely to be more cost-effective than the insurance offered by the dealer. 

While the insurance product is most often referred to in the press and at dealerships as gap insurance, some companies, such as Progressive Insurance Company, call it loan/lease payoff coverage.  And there might be other names, but your agent will know the ones that apply to the products of companies he or she represents.

If you decide gap insurance is a good idea for your situation-and remember, you would otherwise be self-insuring for losses during the time when your car’s loan exceeded you car’s value-discuss gap insurance with your agent when you start looking for your new car.  You will want to ask your agent to investigate the instances in which a company’s gap coverage would not kick in, and how it would pay if it did.  Some policies pay replacement value for a totaled car, even if replacement value is thousands higher than when you bought the car.  Others pay only the total owed on the car.  And still others pay a percentage of the total owed, leaving you to self-insure for part of that gap.  Some companies also require that you place your collision and liability insurance with them as well, but you may well get a discount for ‘packaging’ all of it; your agent can help you through this

If you think gap insurance is just another little bill to pay, remember this essential fact: having it may make the difference between surviving the loss of a car in good shape, or in great distress.