Losing your vehicle to a car accident is a significant disruption and loss. If your car was financed and you still owe a balance on that loan, there could be serious financial repercussions too. Does your auto insurance pay off the balance of your car loan if your car has been deemed a “total loss”?
There are two things to consider when it comes to the value of a car that is financed – the blue book value of the car itself and the actual amount you owe on the loan. Your vehicle depreciates in value the second you drive it off of your dealer’s lot. The older your car gets, the faster the car depreciates in value, and the more complicated this question becomes.
The value of your car is determined by something known as the Kelley Blue Book. This is a standard tool used by most insurance companies, private sellers, and dealerships. It lists the year, make and model of a car and it allows the value to be calculated based not only on the age but on the condition of the car. The older a car, the less it is worth.
The problem, in terms of a car that is financed, is that drivers may become “upside down” on their loans. The car depreciates in value and ultimately becomes worth less than the amount still owed on the loan. You could very easily, for example, have a car with a Kelly Blue Book value of $15,000 while still owing more than that to your finance company.
Each automobile insurance company has its own rules in determining whether a car is a total loss following an accident. But typically, when the cost of repairing a car exceeds a certain percentage of the value of the car, the vehicle is declared a total loss. The percentage most insurance companies’ use is 80%.
Let’s look at a real world example. After an auto accident the insurance company determines that your car was worth $15,000. If we apply the 80% rule”, the insurance company will look to see if the cost of repairs will be more or less than $12,000 (which is 80% of $15,000). If the repair costs will be less than $12,000, the car will probably not be considered a total loss and the insurance company will authorize the repairs. But if the cost of repairs is greater than $12,000, the insurance company will make the decision that the vehicle is a total loss. The insurance company will authorize no repairs and instead will write you a check for the value of the car on the day of the accident. In this scenario the check will be for $15,000.
The check you receive from the insurance company will have your name on it as a payee. However, it will also have the name of any lien holder (the name of any bank or finance company that has loaned you money to purchase the car.)
The insurance company is required to include the lien holder as a payee on the check to ensure that the money goes toward paying off any loan you have on the car. Legally, any bank or financial lender with which you have a car loan has the right to be paid first out of any total loss proceeds that an insurance company pays out for the vehicle.
As in the example above, if you end up in a car accident and your car is totaled – no longer drivable or fixable, your insurance company is only obligated to pay you the depreciated value of your car. Your insurance company will pay you, and by extension, your finance company the $15,000 that the car is actually worth. If you have an outstanding loan balance on the car after the insurance payment, you are responsible for paying this amount out of pocket.
Cars depreciate in value as they age and several factors determine their value, including the make and model, mileage, and the condition of the car. Unfortunately, there’s a misconception that the car’s value is identical to the amount owed on the car loan.
In the best of circumstances after a total loss, the check you receive from your insurance company will be for an amount greater than what you still owe to the lender. So, after paying off the car loan, you might have a little money to put toward purchasing a replacement vehicle.
But that is not always the case. What happens if your loan amount is larger than the amount of the insurance company’s check? You are still responsible for paying off the loan and legally obligated to make your monthly payments to the bank or financial lender until the loan is paid in full. The fact that your car was a total loss does not change your loan repayment terms. Regardless of whether you still own the car, the bank or lender still has the right to full repayment of the loan.
There is a solution, though. When you purchase your car, your dealer will ask you if you’d like to purchase a product known as “gap insurance.” The premium is usually a few hundred dollars and can be rolled into your car payments. Gap insurance lasts the life of your loan and will pay the difference between the value of your car and the balance left on your loan in case of a total loss. Your out of pocket costs with gap insurance are nothing.
Your personal financial situation will dictate your decision to purchase gap insurance. But, it is important to think about adding this extra layer of security. For just a few hundred dollars, it’s worth considering – especially if you don’t have a lot of extra cash in savings or a cushion for this type of unexpected expense.