When consumers discuss auto insurance, a lot of times the term “full coverage” will get thrown around, but the actual definition of that term can vary depending on who you’re talking to.
In this series, we’ll look into incidences where motorists may believe they’ve purchased an insurance policy that fully insures them, but that might not necessarily be the case.
‘Basic’ vs. ‘Full’ Coverage
When vehicle owners look to get insured, they generally either choose to go for basic or full coverage. The term “basic coverage” often implies that the insurance policy will meet the state’s minimum legal auto insurance requirements, while the term “full coverage” usually implies that policyholders will be fully insured following a loss, both for other people’s damages they’re responsible for and for damages to their own car.
But mistakenly believing that your “full coverage” auto insurace policy will fully cover all accident or loss-related expenses can leave you with a pretty hefty bill after a loss. You should be aware that even though your policy will cover a large portion after a loss, there is likely to be a gap in your protection that you may not have considered.
In this installation of the series, we’ll look at the potential costs you may have after totaling a financed car.
Vehicle Damages Not Always Totally Covered after a Loss
One area where vehicle owners may feel they are fully protected with “full coverage” is when their cars are considered a total loss, but this may not always be the case.
Insurers will declare cars to be a total loss when they are stolen or when the cost of replacing the vehicle comes close to the value of the vehicle. Unfortunately, after extensive losses like these, a policyholder may still end up paying for the car after the claim has been paid, though the amount will probably be much less than if the vehicle had been insured through only basic coverage.
For auto owners to insure against physical damage caused to their own vehicles, they must first carry comprehensive or collision insurance coverage, but these coverages will only cover up to the insured vehicle’s actual value. In many cases, when cars are initially financed, the value of the financed vehicle can be less than what the owner actually owes on the loans; this is called being “upside down” on a loan.
When this happens, and an insurance claim is filed on a totaled vehicle, the insurer pays only the actual cash value (ACV). This could leave a gap between the ACV and the total financed amount, which the owner now has to make up.
For example, if you were to buy a new car for $30,000, it could depreciate in value by up to 30 percent in the first year. That means, after a total loss, the insurer may only hand over $21,000 after a claim if it was totaled in the first year.
According to an Edmunds estimate, a $30,000 car depreciates by about $3,340 as soon as it’s driven off the lot. So if you financed a good portion of the car’s cost, the insurer’s claim payment may not be enough to pay off the loan balance.
So say you’ve paid a 10 percent down payment — an Edmunds analysis showed an 11 percent average down payment in 2011 — toward the purchase of your new car, which means that you’ve put $3,000 down and financed $27,000. After a total loss, your insurer would pay the depreciated value — or in this example, $21,000 — to your lender, minus any applicable deductible, leaving you to repay the remaining balance on a car that’s now too wrecked to drive.
Depending on the terms of your loan, interest rate, and the amortization schedule, you could owe your lender thousands of dollars after a claim.
The Solution
Fortunately, there’s protection against being stuck in a situation where you find yourself paying for a car you no longer own or drive; it’s called GAP insurance. GAP stands for guaranteed asset protection and will pay the difference between the amount owed to a policyholder’s lien holder and what his or her comprehensive or collision insurance policy pays after a claim.
Vehicle owners can get GAP insurance from a number of places, including their current coverage provider or the dealership where they purchased the car. However, purchasing this protection through a dealership is usually more expensive than when purchased through an insurer. Dealerships can charge anywhere from $500 to over $1,000 for GAP to cover the life of the loan, but by shopping around, you should be able to find it for less than $100 per year.
GAP Coverage vs. Auto Loan/Lease Coverage
It’s worth knowing that instead of GAP, many carriers will offer what is called auto loan/lease coverage or auto loan/lease gap coverage, and, although very similar, there is an important difference between the two.
Instead of paying the difference between what is paid by the comprehensive and collision insurer and what is owed to a lender, loan/lease coverage will pay up to 25 percent of the car’s actual cash value. In the example given above ($21,000), this would provide up to $5,250, which would probably be enough to cover it, but may not be in every situation. You should make sure by estimating the difference between the value of your car and what you owe on it.
