Gap Insurance: Interview with LeeAnn Shattuck

October 21, 7:46 PMNews You Can Use ExaminerMary Schwager

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Your car is totaled in a crash! But thank goodness you have insurance to cover the damage and pay off your auto loan, right? You could be wrong ! An increasing number of drivers are getting hit with terrible accident after shock. Their insurance company cuts the check but they still owe $5,000, $10,000 even $15,000 on their loan for a car that's gone to the junk yard.

How does it happen? Your car could become "upside down" in value, meaning it depreciated faster than you could pay it off. In recent years car prices have gone up, loan terms have gotten longer and drivers with extreme car envy agreed to zero down payments and higher interest rates to get the set of wheels they absolutely had to have. 

How can you avoid being haunted by your car's ghost? First, consider if you are buying too much car. It may fit in your garage, but does it really fit in your budget?  Would a car that costs less, with a shorter more manageable loan work?  

If you absolutely have to have that wallet risking ride, you may want to consider getting "gap insurance" to cover any additional pay out you could face if your car is totaled. LeeAnn Shattuck runs Women's Automotive Solutions and has seen clients left owing thousands of dollars after a loss. She explains Gap Insurance 101:

Mary Q:  What is gap insurance?

LeeAnn Shattuck, Chief Car Chick: Gap insurance is a policy that "fills the gap" between the amount you owe on your loan and the actual cash value settlement paid by your insurance company in the event of a total vehicle loss. For example, let's say you total your 2 year old car that you originally financed for 72 months. Your insurance company generously gives you $15,000, but you still owe $18,500 on your loan. Gap insurance will pay the $3,500 difference. If you did not have gap insurance, you would owe that $3,500 out of pocket!
 
Mary Q:  But you pay for auto insurance to cover your car if it's wrecked. Why would you need gap insurance?

LeeAnn Shattuck, Chief Car Chick: Because auto insurance is completely separate from how you may have financed the vehicle.  The auto insurance you pay for reimburses you for the market value of your car in the event of a total loss from an accident or theft.  That market value is independent from the amount you may or may not still owe on the loan.  How you financed the car is YOUR problem, not the insurance company's.  
 
Mary Q:  If your car is totaled, can the insurance company really tell what dents and dings were there pre-accident to claim it's worth less?

LeeAnn Shattuck, Chief Car Chick: That depends on the nature of the damage.  If the vehicle was demolished beyond recognition in the accident, then the insurance adjuster may not be able to tell anything about the car's pre-accident condition and will give a figure based on the year, make and mileage of the vehicle.  If, for example, the car was totaled in a front-end accident, but the insurance adjuster noticed damage to the back end of the vehicle that was clearly due to a different incident, then he or she will take that into account in the appraisal.  If the adjuster can tell that the interior condition of the vehicle was poor or it had been smoked in, then that could easily lower the appraisal value.  
 
Mary Q: Experts say the moment you drive a car off the lot, it starts depreciating. What are reasons it would depreciate so much that you would need gap insurance?

LeeAnn Shattuck, Chief Car Chick: The average vehicle depreciates at least 20% in the first year of its life.  Some vehicles depreciate as much as 40% or more (i.e. Range Rovers, Escalades, and pretty much anything wearing a GM or Chrysler badge these days).  Other vehicles, like Hondas and Minis, hold their values very well.   This is due to the fact that a brand new car with no "history" is significantly more valuable to most people.  Why buy a vehicle that has even 5,000 miles on it and risk there being something wrong with it when you can spend X dollars more to get a brand new one?  It also depends on how many miles you put on a vehicle each year.  More mileage = lower residual value.      
 

Mary Q: Who needs gap insurance and when do you buy it?

LeeAnn Shattuck, Chief Car Chick: Whether you need gap insurance primarily depends on how you finance the vehicle. If you buy a vehicle that holds its value well, put at LEAST 10-15% down, and finance for no more than 48 months, then you can probably skip gap insurance.  Unfortunately, most people are not in a financial position to do this and choose to finance their new (or pre-owned) vehicle for 60+ months with little to no money down.  That means that most people should consider gap insurance.

 
Mary Q: How much does it cost?

LeeAnn Shattuck, Chief Car Chick: Gap insurance is a one-time fee that typically ranges from $400-800 through the dealerships. The price may also depend on the length of the loan term (the longer the loan term, the higher the risk of a "gap", therefore the higher the cost for the gap insurance).   Women's Automotive Solutions sells gap insurance for $260 - $360, depending on the loan term.  Gap insurance may also be available through your regular insurance agent, depending on your home state.
 
Mary Q: Do dealerships typically offer gap coverage without the consumer asking?

LeeAnn Shattuck, Chief Car Chick:  Always. The job of the "finance manager" at the dealership is to sell gap insurance, extended warranties and other products that represent a significant portion of the dealership's profit.
 
Mary Q: Do dealerships get a cut or make money off of gap coverage?

LeeAnn Shattuck, Chief Car Chick: Yes, and they should.  But, the mark up on gap insurance, warranties and other "finance products" can be very high, so be sure to shop around before you get to the dealership and negotiate!
 

Mary Q: Do dealerships have to warn customers about the chance a car could become upside down in value?

LeeAnn Shattuck, Chief Car Chick: Dealers are not required to disclose this possibility, but they do usually bring it up in the finance office as a means of selling gap insurance.  In the past, lenders were more conservative and only allowed customers to finance cars for 48 months and required a down payment of 20%.  As cars became more expensive, and customers wanted to buy more expensive cars than they could afford, the manufacturers (captive finance companies) started offering longer loan terms to increase car sales.  Other lenders followed in order to get the finance business. 

Typically, the lender will offset the risk of a longer loan term by charging a higher interest rate - usually a point or two higher for 60 or 72 month loans.  Yes, they risk some people not being able to repay them in the event of a total loss, but on the whole, they make enough money across their entire portfolio of loans to offset this risk.  And, they love people to buy gap insurance. 

For more on this topic and other automotive mysteries and tips, check out LeeAnn's website.