Average new vehicle finance terms have been steadily rising over time.
Experian Automotive reports the average new-car loan lasts 66 months, with a loan balance topping $28,000. Seven-year loans aren’t uncommon, and major lenders such as Ally Financial and Toyota’s lending arm now make 84-month loans.
One New York credit union offers a 96-month loan.
"During the last 10 to 12 years, people have been encouraged to finance cars in different ways. The manufacturers are straining to get people into cars and that has resulted in a whole bunch of trends that are very interesting," says analyst Phil Reed of Edmunds.com. "Automakers and manufacturers are always trying to drum it into people, ' Hey you can afford this car…' One thing I have learned is just because you are approved for a loan doesn't mean you should take it."
While the longer loans give you more time to pay, they also increase the risk of financial disaster if the car is totaled or stolen.
A broad rule of thumb is that cars depreciate 25 percent in the first year, lose half their value after three years and are worth about two-thirds their purchase price at five years. But balances on longer loans don’t shrink as quickly, leaving drivers financially exposed.
A $28,000 car bought with no down payment would be well “under water” in the first year under almost any new-car loan, and in the red after three years on any loan longer than five years. On an 84-month loan, you’d owe more than the car is worth for 60 months.
That's why it's wise to find out more about gap insurance.
If your car is totaled or stolen and you owe more to your lender than it's worth, gap insurance kicks in. It pays the difference between the actual cash value of your car at the time of the loss, less your deductible, and any greater amount owed on the vehicle to a lien holder at the time of loss.
Because you borrowed money to buy your car, your lender requires that you purchase full coverage – not just state-mandated liability insurance, but collision and comprehensive coverages that pay for damage to the car itself – to protect its investment.
But no insurance company will ever pay you more than the car is worth if the vehicle is stolen or totaled.
“You can and should hold out for the best offer you can from your insurance company,” says Des Toups, managing editor of Insurance.com, “but in the end you’ll get a number based on the car’s actual cash value, minus your deductible, the moment before the accident. What you owe isn’t a factor.”
The difference between those numbers is the gap you want to cover.
"Gap insurance is really insuring the difference between the actual cash value on the vehicle and what you owe on the vehicle," says Bryan Smith, second vice president, Travelers Personal Insurance, Hartford, Conn., noting the insurance was born by lease vehicles that automatically carry gap coverage.
Toups recommends new-car buyers look at gap coverage for at least the first year if they have not made a down payment of at least 20 percent of the car’s out-the-door price.
“Even someone with a short loan can have an accident on the way home from the dealership,” he says.
What you’re aiming to cover, he says, is the period when the combination of a deductible, a big unpaid balance to your lender and the scramble to buy another car would spell financial disaster.
“At a certain point, you might be able cover the gap with your savings,” he says. “And once you’re in positive territory on the loan, gap coverage is a waste of money.”
Compare gap car insurance quotes before you buy your car. Yes, most auto dealerships offer gap insurance, but the cost of the insurance may well be 50 percent higher than what you'd pay if you secured it through your insurance agent, says veteran credit insurance professional Scott Henderson of Corona Del Mar, Calif.
"Prices [for the same policy] can range from $300 to $700," he says. "It's one of many things that [a consumer] should educate themselves about before they go to the dealership. Many people have their first exposure to gap at the dealership."
You can buy gap coverage through many insurance companies, too. They often refer to it as loan/lease payoff coverage. Expect to pay 5 to 6 percent of the combined annual cost of your comprehensive and collision premiums. That is, if you pay $1,000 a year for comp and collision, you pay an additional $50 to $60 a year for gap coverage.
Your bank or credit union may offer gap coverage as part of its loan package.
Lastly, there are stand-alone gap providers, such as GapDirect.
In all cases, Toups says, check the conditions under which you are allowed to drop the gap coverage and whether you get a refund of the unearned premiums.
How quickly the vehicle depreciates, the economy, the amount of the down payment and the specific coverage of the insurance policy are all important factors, says Nancy Smeltzer, a spokeswoman for Nationwide.
"A comparison of the vehicle's current value with any unpaid amount due on the loan or lease is a great place to start," she says. "Your insurance agent can also assist by reviewing those values with you and helping to determine how long you should maintain gap coverage."
Remember that most, but not all, gap insurance automatically ends after a specific amount of time, for instance, five to six years, so you don't continue to pay for it when it is no longer needed.
Still, you may want to remove it even sooner, so talk to your agent about vehicle depreciation and your loan amount so you make a wise decision, says Henderson.
To buy this gap, you must have collision coverage and comprehensive coverage as part of your car insurance policy. (See Insurance.com's Auto Insurance Coverage Calculator and Recommendations.)
Before gap kicks in to pay the difference to your lender, your car has to be declared a total loss and your insurance company needs to pay out first. If your gap policy doesn’t cover your deductible, then you’d need to pay that, too.
If someone else is at fault, gap still pays and under the same conditions. You would not need to pay your deductible, though.
Gap doesn’t pay for anything except a total loss. It does not make up missed payments and late fees if you lose your job, if you need a rental car, or if the car is repossessed. It does not pay the rolled-over balance from any previous loan. It does not pay the unused balance of extended warranties.
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