Saturday, October 25, 2014
Search: 

Gap Coverage Protects "Upside Down" Car Buyers



After a home, a new car is the largest purchase many of us ever make. With such a big part of your financial worth riding on four wheels, a totaled or stolen vehicle may break not only your heart, it could break your budget, too. As many drivers have learned only after it's too late, a standard auto insurance policy might not provide all the financial protection you need. If the value of your car is less than the balance of your auto loan, you're "upside down" on your loan, and there's a gap that isn't covered. That difference is what a special type of protection, called gap coverage, is designed to cover.

Negative equity puts car buyers at risk

As if seeing your new midnight blue beauty crushed by a falling tree, tossed around in a hurricane, crunched in an accident, or stolen and stripped weren't punishment enough, imagine having to continue making loan payments on a vehicle you no longer can drive. To see just how you could end up in that situation, consider this scenario, in which your car has taken a trip downriver during a record-breaking flood just one year after you drove it home from the lot:
  • Amount you owe on your auto loan $20,000
  • Your car's book value at the time of loss 15,000
  • Your insurance deductible 500
  • Amount the insurance company pays you 14,500
  • The gap $5,500

Gap protection is intended to cover the difference between the value of your car at the time it's totaled and your outstanding loan balance, which you still are responsible for paying even if your car is sitting under 10 feet of water. Depending on what state you live in and the type of coverage you choose, your insurance deductible may be covered as well.

Except in a few states, gap protection is not, technically, insurance, though it is commonly referred to as such. It's actually a debt cancellation agreement. It waives the section of your financing agreement that holds you responsible for the difference between the value of your totaled car and your remaining loan balance. Regardless of what it's called, this coverage satisfies your liability to pay the gap.

It pays to check with your credit union before you buy elsewhere.

Not everyone needs gap coverage, but thanks to some significant changes in the way cars are bought and financed, more and more drivers are finding they could use the extra protection.

Do you need gap protection?

Only car buyers who will owe more than their vehicle is worth need to consider gap protection. For buyers putting little or no money down, rolling an unpaid balance on their old car loan into the new loan, or taking out an extended-term loan (60 months or longer), the need for gap coverage may be obvious. Others have to take into consideration the expected depreciation on the car they're buying and the rate of equity accumulation through their auto loan. This will help you figure roughly how big a gap you'll have and for how long.

A car starts depreciating as soon as you buy it, with the most drastic loss in value occurring as you drive off the lot and the vehicle goes from "new" to "used." To get some idea of the anticipated depreciation amount, try the calculator at CarPrice.com. (On the "Select your page to visit" drop-down menu at the bottom of the page, choose "Calculators"; on the next page, choose "Depreciation Calculator".) Bear in mind that cars depreciate at different rates, so a calculator that doesn't consider the vehicle's make and model really can give only a rough estimate. You may be able to tweak that estimate by factoring in past depreciation on a specific car type. Check Kelley Blue Book online to see how much last year's model is worth today. Ultimately, any depreciation estimate is really just an educated guess.

Between the value of your car and the balance of your auto loan is a gap that isn't covered.

After researching depreciation, use your loan amortization schedule or an online calculator such as the one at Bankrate.com. Fill in your loan information, and then click "Show/Re-calculate Amortization Table" to:

  • See your outstanding loan balance at any point during the loan term.
  • Find out how much of your monthly car payment is going to principal vs. interest.
  • Find out how long it will take you to pay the gap.
Some buyers don't have to decide about gap insurance at all. Sometimes the lender or leasing company includes the coverage in the agreement for the lender's protection. This is particularly common in lease contracts. For others, the decision to buy gap coverage is just the first step: Deciding whom to buy it from is the bigger challenge.

Shop around for savings

There are a few sources for gap coverage: your credit union or other lender, online sellers, and your auto insurance company. Of course, there are things to know about each option before you buy.

The Internet makes shopping easy and convenient, and often leads surfers to great deals on everything from books to bookshelves. If you'd like to see what the Web has to offer, try a search for key words such as "gap insurance" and "auto gap coverage." As with all online services, make sure you thoroughly research the company behind the offer before you send money or provide information such as your credit card, driver's license, or Social Security number. A few dollars saved isn't worth the worry that a provider won't come through when you have to file a claim.

Your auto insurance carrier may be another option, though not all insurance companies sell gap coverage; you'll have to check directly with your agent. Some auto insurance policies actually include a certain level of gap protection as part of their regular comprehensive automobile coverage, so check on that, too, before you buy. If you do decide to buy gap coverage from your carrier, the cost likely will depend on the value of the car you're buying (you'll pay more for gap coverage on a Mercedes than you will on a Hyundai) and will show up as an extra charge on your auto insurance premium statements. That charge will continue to appear until you cancel the coverage, which means that it's your responsibility to calculate when you're out of the hole--you've closed the gap by paying down your loan--and contact your agent to remove the extra coverage. If you forget, you'll pay for protection you no longer need.

Imagine having to continue making loan payments on a vehicle you can no longer drive.

Most often, people purchase gap coverage through the lender--usually the dealership, a credit union, or bank--at the time of the purchase or loan transaction. The cost is normally a one-time charge, typically the same set price for all customers buying the same coverage. Buyers may roll the fee into the total loan amount and include it in the monthly loan payments.

As is the case with auto financing, dealerships rarely offer the best price for gap coverage. According to Rich Fischer, vice president of credit insurance products for CUNA Mutual Group, which provides financial services and products to credit unions and their members, the average retail price for gap coverage through a dealer is around $500. That same coverage through a credit union typically will cost around $250 or $300, proving that it pays to check with your credit union before buying elsewhere.

While saving a few hundred dollars on gap protection is nice, the bigger incentive to shop around is the much greater savings from a lower interest rate on your loan. According to the comparison of bank and credit union loan rates from Datatrac on cuna.org, in December 2004, the average rate for a 48-month new-car loan from a bank was two percentage points more than through a credit union.

The bigger incentive to shop around is the … lower interest rate on your loan.

On a $20,000 loan at 5% interest, that nearly two-percentage-point rate difference would save the credit union borrower a whopping $880 over the course of the loan. You'll likely see the same--or greater--savings when comparing credit union rates against car dealers' rates. (Tip: When comparing financing offers, be sure the dealership commits to a financing rate and car price that considers your income and credit information. Some dealers increase the vehicle price to compensate for a lower interest rate, or tell you that, based on your credit score, you don't actually qualify for the low interest rate they originally quoted.)

If you have several gap coverage alternatives, don't decide solely on price. Less expensive coverage may actually offer less protection than another, more expensive, waiver. For example, the most basic coverage pays the difference between the insurance settlement and your outstanding loan balance. Another type of coverage reimburses you for the insurance deductible as well. And still other offerings include features such as vehicle replacement, even if the price has gone up, or a thousand dollars to put toward a new car.

When shopping for gap coverage, you should:

  • Compare any quotes on gap coverage and auto financing with what your credit union can offer you.
  • Understand the benefits offered with each option and compare apples to apples.
  • Read your lease or gap coverage document to make sure you're covered for all types of total losses, including accident, theft, and natural disaster.

It's not uncommon these days for car buyers to start out as much as $15,000 in the hole, so gap coverage can provide a great value for the money. "Even $500 at the dealer is better than nothing if you're seriously in the hole," says Fischer about the cost of gap coverage. Of course, he'd rather you call your credit union and save.

Owing significantly more than your car is worth is a warning sign.

If you need gap coverage, buy it. But understand that owing significantly more than your car is worth might be a warning sign that you can't really afford a new car in the first place. Before you sign on the dotted line, consider driving your current car a little longer, or buying a less expensive car so you can borrow less. If you buy a used vehicle, you'll also avoid the steep depreciation new cars suffer in the first few years. And without a mountain of debt to worry about, you can sit back and enjoy the ride.

How did I end up in the hole?

There are a few reasons more car buyers find themselves "upside down" (when your car is worth less than you still owe on it) these days:

    Low- and no-downpayment purchases: When you buy a car with little or no money down, you can end up on the wrong side of the equation the instant you drive off the lot. Say you buy a car with a $25,000 price tag. You put $1,000 down, finance the remaining $24,000, and also roll into the loan the cost of tax, license, and registration, for a total beginning balance of $27,500. Depending on which car model you buy, your depreciation could be as high as 25% after the first year, putting your "book" value at $18,750--nearly $9,000 less than what you financed!

    According to car-buying experts, you should be ahead of the depreciation curve and close the "gap" if you put at least 20% down on your vehicle.

    Extended loan term: An extended loan term also can put you in the hole right from the start. According to a March 2004 report from Power Information Network (PIN), an auto industry research and reporting affiliate of J.D. Power and Associates, Westlake Village, Calif. the average length of a new-vehicle loan was 58 months, up almost 10% from three years before. And statistics show this trend continuing, with a growing number of drivers choosing longer-term loans--up to 96 months! A longer repayment period means lower monthly payments, which results in slower equity accumulation. The longer repayment period also means you pay more for the loan. A buyer who would be upside down for only a year with a 48-month loan, may be upside down for two or three years with a much longer-term loan.

    You should be ahead of the depreciation curve if you put at least 20% down.

    Low used-car values: Booming new car sales have flooded the market with used vehicles, weakening trade-in values and accelerating depreciation.

    To get the most out of your old car, consider selling it yourself. When you trade it in to the dealership, the dealer discounts the value by the amount of profit he needs to make on the resale.

    Avoid the fastest-depreciating cars by researching which autos hold their value best. Start at Bankrate.com, which offers a very helpful article about identifying the best and worst values.

    Frequent trade-ups: Consumers are taking dealers' bait and trading in their current vehicles--which may be only a few years old--for shiny new ones. In many cases, the old car's trade-in value isn't sufficient to pay off that loan, so the borrower rolls the balance into the new purchase loan, instantly falling deeper into the hole. PIN reported that, while only 25% of trade-ins were upside down in 2001, 38% of trades were in that position as of March 2004. And the situation gets worse with every trade, until you finally pay off your existing loan before getting another car.

    To avoid getting into the negative-equity cycle:

    • Anticipate when you will need a new car.
    • Calculate how much you comfortably can afford to pay within a reasonable loan term.
    • Pay off the balance on your existing loan before you buy something else.
    • Sell your old car yourself to get the most out of it.
    • Be prepared to put down at least 20% on your new car purchase.


American Share Insurance - ACU deposits are insured up to $250,000 per account. By member choice, ACU is not federally insured. Equal Housing Opportunity

  Home & Family FinanceŽ Resource Center
  Copyright © 1997-2013 Credit Union National Association Inc.

 
Abri Credit Union