Loan/Lease Difference in Valuation
Avoiding the insurance pot holes means you also have to consider Gap Insurance. Gap Insurance means the difference in valuation at the time of a loss, and it is almost inevitable today if you lease or finance your car purchase. Fifty years ago it was commonplace for a bank or lender to expect you to put up 20-30% to buy a car and only then would they would fund the balance of the purchase. This helped assure the banker that they had some equity in your vehicle in case you stopped making payments. Today, the lender is exposed to the difference in valuation making gap insurance essential if you want to be clear of your loan or lease obligation after a car is damaged beyond repair in an accident.
Today, modern lending practices have evolved to the point where in most instances any credit worthy person can buy a car with no money in the deal. In some cases it isn’t even required that you make the first payment before leaving the dealership. These practices and others make it likely you’ll need gap insurance. Fifty years ago leasing wasn’t a popular option available to get a new car. While leasing activities ebb and flow, these days they are popular again because many people find it difficult to manage the higher payments required under purchasing. On a lease arrangement the buyer is only financing a portion of the purchase price and the residual value is unfinanced. Lease cars never become our property but we are responsible for the number of payments and mileage limitations we accept in our auto lease.
All of this leads us to the reason that Gap protection on new car purchases and leases is so important. As mentioned, the cost of cars are often beyond the ability of the buyers to pay if their payment stream were compressed into 3 or four years, as was common fifty years ago. Today, payment terms extend from 72 to 84 months. That creates some interesting math problems when there is a loss that totals the vehicle (an event that is not necessarily rare these days).
A gap develops because our payment plan stretches out for much longer than in the past. New cars depreciate rapidly during the first two or three years and especially during the first two. The rate at which the loan/lease balance declines on the original principal goes down slower than the rate at which the new car depreciates. This creates the Gap between the loan balance and the value of the car. Autos, except in rare situations, are settled based upon their value at the time of the loss. We refer to this valuation as “Actual Cash Value” but it generally equatable to the amount at which we can replace the car in the used auto marketplace with one of similar year, make, model, features, similar wear and tear and miles, and of similar condition. A typical example might be the following
- 2013 Toyota Camry LE 18,200 Miles is totaled.
- The NADA Valuation Guide says it is worth $12,600
- The remaining loan balance is $14,700
- The insurance company owes the loss of $12,600 leaving a $2,100 Gap in protection.
- Gap Insurance pays the $2,100 difference in valuation
A Gap insurance protection endorsement for the loan or lease difference in valuation would pay the $2,100 gap as part of the settlement to resolve you of the debt for the car. Many clients end up upside down on their financing in these situations and end up rolling these shortages into the next loan. This practice only magnifies the difference in the valuation leaving an even bigger gap if the same events were to happen again.
The cost of Gap insurance Protection with your insurance company is very inexpensive, often costing $15-30 dollars for the policy period. The auto dealers also want to sell this product as it protects them too if the loan goes upside down. If you buy this from your auto dealer it is wise to remember that it is likely much more expensive to buy this coverage and, the cost is added onto the loan and interest accrues on this coverage too. You pay for this coverage for the entire loan term rather than a six or twelve month period of time with your insurance. On the plus side, coverage bought from auto dealers is designed to cover the term of the loan. The coverage may not have limitation to the difference in valuation. Insurance coverage usually is subject to a maximum percentage difference in valuation. If you are way out of formula when you borrow for your next auto purchase or lease, your best option might be to buy the dealer coverage if there is no limitation to the difference in valuation. On the whole, however, in the majority of situations it is much more expensive to buy this coverage from a dealer than to buy it from your insurance company so keep this in mind as you buy or lease new cars.
Auto Insurance Topics
- Bodily Injury & Property Damage Liability
- Uninsured Motorist
- Underinsured Motorists
- Medical Payments
- Collision Coverage
- Comprehensive Coverage
- UMPD Coverage
- Road Service
- Rental Car Coverage
- Gap Insurance
- Other Coverage
- Auto Endorsements
- No Fault Law
- SR22 Filing
- Coverage in Canada
- Coverage in Mexico
- Sample Auto Policy
- Definition of Liability
- Understanding Your Auto Insurance Policy
- Auto Insurance Declaration Page
- Ohio Auto Insurance Quote