Close the gap in your car insurance

By Liz Pulliam Weston

If you did everything wrong while acquiring your last vehicle, you may still be able to do at least one thing right. And that's buying so-called "gap insurance."

Gap insurance kicks in when the amount your insurer would pay for your totaled or stolen car falls short of what you still owe on the loan or lease.

Chances are good you need gap insurance if:

• You purchased a new car and didn't have a down payment of at least 20%.
• You're leasing a car.
• You're financing for more than four years.
• You rolled debt from your last car into your current auto loan.

I outlined why these car-buying practices are usually bad ideas in "The real reason you're broke." They are, unfortunately, fairly common scenarios that typically leave people "upside down," or owing more on their cars than the vehicles are worth.

Yet gap insurance remains a relatively unknown product, said Patrick Olsen, managing editor of Cars.com.

"As soon as you drive off the lot, depreciation kicks in," Olsen said. "I don't think people are aware of the danger they could be in."

If you don't make a 20% down payment, for example, you'll be upside-down on the car from the minute you drive off the lot, and you'll typically stay that way for two to three years, depending on the length of your loan. If you get in an accident or the car is stolen during that time, you may be in trouble.

• Video: Should you buy or lease?

"The insurance company will pay you what the vehicle is (currently) worth, and that's not necessary the same as what you owe," said Mike Meredith, financial editor for MSN Autos. "It could be a lot less."

You could be pushed over the edge

Here's an example. You buy or lease a car for around $25,000. Several months down the road, it's totaled, but your insurance check covers only the car's current value, which is about $20,000. Not only do you have to find new wheels, but you're on the hook to the finance or lease company for that $5,000 gap. It's not uncommon for cars to lose two-thirds of their value in just three years. (See MSN Autos' list of vehicles that hold their value best.)

If you rolled debt from your old loan into your new one, that amount you owe could be even larger. One out of four vehicles that are financed includes debt rolled over from a previous vehicle, according to vehicle research site Edmunds.com, and the average amount of so-called "negative equity" is more than $4,000.

If your finances are already shaky, the gap between what you owe and what you're paid could be enough to push you right over the edge.

 1 | 2 | next >