AUTO
Insurance Payout may not Cover Loan
by Kimberly Lankford

If I total my car, will my insurance company pay the amount I owe the bank on my car loan?

Maybe not. Most auto insurance policies will only pay you for the car's current market value as a used car, which is usually much less than you originally paid when it was new. Even cars that are just a few weeks old generally depreciate significantly the minute you drive them off the lot.

If you took out a four- or five-year loan, the insurance payout may not be enough to pay off your loan -- even if you've already been making payments for several months. It's becoming increasingly common for people owe more than the car is worth. Not only are buyers taking out longer loans, but many cars are depreciating faster than they had in the past (often because car companies are offering big rebates or sales on new models, which forces the prices down on used cars).

Say, for example, you bought a 2004 Chrysler Sebring for $18,500 last fall, with $1,000 down and a five-year loan at 4% interest. After six months and 5,000 miles, you get into a big accident and total the car. You still owe the bank $15,903, but the insurance company pays you only $12,000. You'll need to pay the bank an extra $4,000 from your own pocket (plus the amount of the deductible) just to pay off the loan.

To estimate whether you could have this problem, go to Kelley Blue Book's Web site and see how much one-year-old models of the car you're considering are worth. This isn't the exact number the insurance company will use, but can give you a general idea of how much you could get. Then compare that amount to what you would still owe on your loan. Use the How Much Will My Vehicle Payments Be? calculator to see the balance at various points in a loan's life.

If you do owe more than your insurer will pay, you can solve the problem by buying gap insurance, which lenders and insurance companies offer to cover the difference between a car's cash value when it's totaled and the amount you still owe the lender. The price is usually minor -- averaging about $45 per year from Progressive, for example, or up to $500 or $600 for the life of the loan from many lenders and dealers (you may be able to negotiate a lower price from dealers in many states). And some companies, like MetLife, include some coverage in their standard auto insurance policies at no extra cost -- they'll automatically pay the full cost to buy a new car if you total your car within the first year and have driven less than 15,000 miles.

Gap insurance is worth the cost only if you face a potential gap of several thousand dollars. You generally don't need the coverage if you make a down payment of 20% or more, and you may only need it for just a year or two. As time passes, the size of the gap shrinks.