Plug the Gap in Your Auto Coverage
If you lease a car -- or even if you buy one and put very little money down -- you probably need a little-known type of insurance called "gap" coverage.
As the name implies, gap insurance covers what your regular auto insurance doesn't: the gap between what your insurance company pays if a car is stolen or totaled and what you owe on a lease or loan. Regular auto insurance only reimburses you for the value of your car when disaster strikes, not what it would cost to replace it. And most cars lose between 20% and 30% of their value once they're driven off the dealer's lot.
If, for example, you have $23,000 in payments remaining on a car, and you drive it into a tree, your primary auto insurer might determine that the actual cash value of the car was only $20,000. If your deductible is $1,000, you would be on the hook for $4,000. But that amount would be covered if you had gap insurance.
In the past, gap insurance was only marketed to people leasing a vehicle. That's because most people who bought cars tried to put down at least 20%, or roughly the amount a vehicle depreciates immediately after being purchased. So even if it was totaled before the permanent license plates arrived, the payout from a regular auto policy would cover most of the balance of the owner's loan.
But these days car buyers are putting less and less money down, leaving them with the same gap in their coverage as people who lease.
Philip Reed, editor of Edmunds.com's Strategies for Smart Car Buyers, says that gap insurance has become far more prevalent as lending practices have changed.
"More and more, people are going zero down," Reed says. "With zero down, you drive off the lot with a car that instantly depreciates by 20% to 30%, and you're now 20% to 30% upside-down on your loan."
Auto loans are also getting longer as consumers stretch to buy more car than they can afford. And the longer the loan, the slower you pay off the principal. Ralph Ebersol, director of training at Cars.com, notes that it's not unusual to see car loans of 60, 72 or even 84 months. With terms this long, the balance of the loan that needs to be paid off remains substantially higher than the value of the vehicle for a much longer period of time.
"Gap insurance protects the customer from that difference of loss, and it's a pretty good thing," he says.
Reed says gap insurance is also a good idea for borrowers who roll the remaining balance of the loan on their old car into a loan for a new car. That's an increasingly common practice as people take out auto loans of five, six or seven years.
But he warns that banks and automakers often try to sell gap coverage to people who don't really need it. "Normally if you buy a car and you make a good down payment, you don't need gap insurance," he says.
And while many finance contracts come with gap coverage built in, it pays to shop around if you can.
General Motors Acceptance Corp., a unit of GM
(GM) , and Ford Motor Credit, a unit of Ford
(F) , have recently started offering the coverage, and GMAC is now making it available through dealerships regardless of the brand of car they sell.
But they may not offer the best deals. Insurance websites such as www.gapinsurancecoverage.com list quotes for one-time payments of $300 to $400, which they claim is hundreds of dollars less than the amount charged at dealerships.
Reed of Edmunds.com says the finance and insurance departments of car dealerships engage in what he calls "menu-selling" -- offering a wide selection of add-ons with the idea that "you can't say no to everything and are bound to buy something."
But he notes GMAC's gap product has a cancellation policy that may be a good way for buyers to protect themselves in the short-term and save money over time. "One possibility for a consumer would be to go ahead and accept the GMAC [gap insurance] at the dealership to make sure they're covered, read the fine print to see what the cancellation policy is, and then comparison shop."
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