If you’ve shopped for a car recently, you know the prices are outrageous. Over the past 12 months, prices for new vehicles have risen 12.4%, according to the US Bureau of Labor Statistics, and used cars and trucks have risen 41.2%.
A high auto loan or lease can help cover high costs, but it can leave you “under water” – owing more than the car’s value – if the vehicle is totaled or stolen. While collision and comprehensive insurance will pay for damage to or theft of your car, both types of coverage only pay up to the current market value of your car minus your deductible, and you are responsible for the rest. In some cases, this can amount to thousands of dollars.
Your car dealer may suggest insurance gap, which pays that difference so you don’t have to. In today’s turbulent auto market, gap insurance can be a smart move. But prices vary widely for that extra coverage, so be sure to compare auto insurance rates before buying.
Higher car prices could mean a bigger gap
The “gap” in gap insurance stands for guaranteed asset protection. It covers the difference between the market value of your vehicle and the amount you owe on your car loan or lease. Since cars can depreciate quickly, you may owe more than your car is worth, especially in the first years of repayment.
Current auto market trends may make that discrepancy unusually wide, says Caleb Cook, vice president of consumer lending at Massachusetts-based Digital Federal Credit Union. These include:
- Shortages. A shortage of microchips due to a pandemic means automakers can’t keep up with demand for new vehicles. With fewer new cars available, sellers can charge higher prices for any vehicle a buyer is able to obtain, whether new or used.
- Supplements. Some new car buyers end up paying extra, “between $5,000, $10,000 or even more for luxury cars,” above the manufacturer’s suggested retail price, or MSRP, says Brian Sullivan, a independent insurance broker at Avail Insurance Solutions in Oakland, CA.
- Long term loans. To make high-priced cars more affordable, lenders are extending their financing terms, with seven-year auto loans no longer unusual, Cook says. This means lower monthly payments, but the loan balance stays higher for longer, while the value of the car depreciates.
These factors add up to a greater chance of being “upside down” on a car loan or rental, owing more than the value of a car, according to Cook. “People take out longer-term financing, take out bigger loans, pay a little more than MSRP, or pay a premium for a used car,” he says. “Their potential to be upside down is so much more.”
Buyers may not worry about vehicles losing value while used car prices are high, but this effect is likely temporary. When the auto market eventually corrects, those who paid high prices for cars will be especially at risk, Sullivan says. Values could plunge, widening the gap between what a car is worth and what it is owed.
Is gap insurance worth it?
“Anyone buying or leasing a new car or truck should consider gap insurance because the vehicle begins to depreciate the moment it leaves the parking lot. In fact, most cars lose 20% of their value within a year” said Loretta Worters, vice president of media relations at the Insurance Information Institute, via email.
You might especially want to consider gap insurance, Worters said, if:
- You have financed for 60 months or more.
- You have paid a deposit of 20% or less.
- You have purchased a vehicle that depreciates rapidly.
- You have rented the vehicle. Indeed, some leases may require gap insurance.
If you don’t have a car loan or lease, or have a large down payment, you don’t need gap insurance.
What to know when buying gap insurance
You can purchase gap insurance through your insurer, lender, or car dealership, but Sullivan says it’s probably cheaper to go through your insurer. “The premium can be very cheap. Typically, you can start at $19 per year for gap coverage,” says Sullivan.
For comparison, purchasing gap insurance through a dealership or lender can cost between $500 and $700 in one-time fees.
Typically, you only need gap insurance for two or three years when you’re paying off your car loan. Once the loan balance matches the actual value of your car, you should remove the gap coverage from your policy.
If you didn’t purchase gap insurance when you bought your car, you may be able to add it later. Some insurers sell gap insurance for vehicles that are no more than two or three model years old.
In Cook’s opinion, gap insurance is worth considering.
“The current environment will not last forever. We will find the shortage,” he said. “So I think in the short term the gap is probably bigger now than it has ever been.”
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Ciarra Jones writes for NerdWallet. Email: [email protected]et.com.
The article Why Rising Car Prices Make Gap Insurance Interesting a look originally appeared on NerdWallet.