Auto Gap Insurance: Why you may need it!

It seems that almost every other TV commercial during the holidays has a gesticulating car salesman telling why you need a new car. Of course, these dealers are trying to move stock by year end. “Hurry before the best deals of the year end,” is an often stated selling point. If you find yourself driving a new car, you may need to think about an auto gap policy for your new car. Gap policies are a useful policy addition that may save you money.

What is a Gap Policy?

A gap policy is a feature that can be added to the policy of a new car. The gap coverage will cover the difference between the auto’s value and the balance of the loan. While I am not an advocate for consumer debt (car loans), those who have new car loans need to be protected. New cars depreciate so rapidly the value of the car may be lower than the payoff of the loan.

Why does this matter?

If a new car owner is involved in an at-fault accident where the automobile is totaled, the insurance company will make payment to the owner. The problem occurs when the automobile is valued at a lower amount than the payoff of the loan. The owner will then be on the hook for the difference without the gap coverage.

Here’s an example: Let’s say Sam buys a $30,000 car and 3 months later is involved in an at-fault accident where his car is totaled. Sam has full coverage and expects to receive payment to cover the pay-off of his note, but, unfortunately, this may not be the case. New cars can depreciate as much a 20% immediately after purchase, so the value of Sam’s car may be as little as $24,000. Even if Sam put down 10% ($3000), his loan pay-off may be roughly $25,500. Sam may have to pay out of pocket to pay off the note, even after being paid by the insurance company.

Gap policies are inexpensive and should be discussed with you insurance carrier if you are a new car owner and have a highly leveraged auto loan. Remember the old insurance axiom: don’t risk a lot for a little. Without the gap policy you could have a potential liability of thousands of dollars.

The Theory and Reality of Emergency Funds

Many times planners talk in terms of financial theory or possibilities, and while clients often heed the advice of their planner they implement the guidance based on theory. A good example of this is in regards to emergency funds. I feel most people understand the theory and importance of having a solid emergency fund, but until a true need for emergency funding is faced the peace of mind liquidity provides may not be fully appreciated.

I recently met with a client who told me a great story. My client had an ah-ha moment. My client had built a solid emergency fund. She understood, in theory, the importance of liquidity (cash), but she had not experienced firsthand the power of a sturdy safety net.

My client was struck with a spell of tough luck….she fell and injured her leg, her mother was in the hospital, and on top of that, her car’s transmission died. Between hobbling around on an injured leg and visits to the hospital, she found time to get her car repaired. The price tag for the transmission repair was lofty.

In the past, financial setbacks for my client would have been dealt with simply by pulling out the credit card and racking up debt, but this time was different. After a couple years of hard work, she had reached solid financial footing and was able to absorb the unexpected cost.

The best part of the story was not so much that my client was able to cover an unexpected expense. The golden moment came when she learned, first hand, the benefit of a fully funded emergency fund. Theory became reality for her.

The moral of the story is financial theories are only theories, but the wisdom behind the theory and advice is sage. When it comes to emergency funds and building a safety net, it’s not whether or not the need will arise to utilize the funds. It’s just a matter of time before Murphy’s law will come knocking on your door. A solid emergency fund is the foundational footing to a solid financial plan and one of the best ways to increase peace of mind. If a good night’s sleep is what you are seeking, propping up the emergency fund may be just what the doctor ordered.

What is a Diminished Value Claim?

Recently, my wife was involved in a little fender bender in a parking lot. She was hit by a young driver who just wasn’t paying attention. The damage was not dramatic and no one was hurt. After gathering all the vital information and contacting our insurance company on the spot, both parties went on with their day.

With almost everything financially related, I strive to seek a nugget of education, and this insurance claim process was no different. The at-fault driver had coverage, and the insurance company was quick into action to set us up with a repair plan and a rental car. Within a little more than a week, we where made whole…..or as they say in the insurance industry: indemnified. But wait, were we really back to where we started? What about the true value or our automobile?

In today’s world of information sharing, insurance companies realize the picture is a bit broader. Even though our automobile was repaired to pre-accident standards, the true value of this asset had diminished. This can now be seen in a Carfax report that will show our car was involved in an accident. If a buyer is deciding between two similar vehicles with the exact same sales price, but one has a clean Carfax report and one shows involvement in an accident, the decision is clear. The buyer will always buy the vehicle with the clean Carfax report. Insurance companies now realize this and offer diminished value claims.

A diminished value claim is an effort to fully indemnify the claimant. In essence, cash is paid to the claimant to fill the gap between what the car was worth pre accident and post accident. Let’s go back to the example of the buyer looking at two similar cars. If the buyer decided the accident was minor and the damage was repaired properly, the buyer may make an offer commiserate to the diminished value…..say $500 less than the car with clean Carfax report. If the owner of the car received $500 from the insurance company as a diminished value claim, the owner was made whole.

The key to a diminished value claim is it must be requested. While the at-fault driver’s insurance was really great to work with, they didn’t offer this without my asking. On another note, the diminished value claim is a negotiable amount. I did not accept their initial offer and asked for what I felt was fair. They agreed.

If you find yourself in an auto accident, remember the true value of your auto may decline more than you realize due to access to information via Carfax reports. Speak to the insurance company about the claim, be patient and courteous, and don’t forget to request a diminished value claim.