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According to a recent Bank Rate Survey, 21% of Americans are postponing buying a car in 2022 due to the state of the economy. However, even if you tried to avoid it, you may have found yourself dumped at the dealership due to vehicle breakdown or an accident. In this upside-down car market, you may also have found yourself buying a new car when you would otherwise have been used. Bankrate explores why gap insurance could be more important than ever for those buying a new car during this time of inflation.
What is gap insurance?
Guaranteed asset protection, or insurance gap, can provide you with financial protection if you owe more on your car loan or lease than the vehicle is worth. For example, a brand new vehicle for which you paid $40,000 might only be worth $32,400 one year laterthrough depreciation.
To put this into perspective, imagine you had to total this vehicle one year into your car loan, which has a term of 60 months at 6% interest. If you did, you could still owe your finance company $37,105 without accounting for depreciation. However, since insurance companies generally use actual cash value (ACV) to determine how much to pay for a total loss, he would pay you what the vehicle is worth after depreciation, which in this scenario could be $32,400. This would leave you with a disbursement of $4,705. If carried, gap insurance would come into play to cover this expense. Otherwise, you are responsible for this balance.
Why is gap insurance important in times of inflation?
While gap insurance could provide crucial financial protection for new vehicles regardless of the economic situation, new car buyers might want to consider whether this coverage is right for them, given today’s market.
Higher than normal interest rates on new car loans
The Federal Reserve has taken drastic measures over the past year to combat an impending recession in raise interest rates at levels not seen in the last 30 years. The Fed says these rate hikes should help stabilize the amount of cash circulating in the market and, therefore, ease demand and lower the price of goods and services.
While the signs indicate that inflation is indeed cooling, Fed decisions can affect how much you pay to borrow money for a new vehicle. Rhys Subitch, auto loan editor for Bankrate, explains,
Rate hikes are not directly related to consumer interest rates, but there is a domino effect. When the Fed rate is higher, lenders tend to raise interest rates on their credit products, including auto loans. A new 60 month auto loan in May 2022 was 4.5% – several Fed hikes later it sits at 6.17%.
—Rhys SubitchAuto credit editor, Bankrate
So what does this mean and how does it relate to gap insurance? In simple terms, the increase the interest rate on your car loan, the more money you pay for that interest rather than your principal balance. The more interest you pay instead of principal, the more money you owe on your overall loan. This chain of events could make it more likely that you overturn your car loan (or owe more than your vehicle is worth), making gap insurance an important tool if your vehicle is declared a total loss.
Longer loan terms due to financial difficulties
The average monthly car payment on a new vehicle is $700, leading more and more Americans to turn to long-term auto loans to make their monthly car bill more manageable. Historically, the most popular car loan term was around 60 months (or five years). However, the shorter your term length, the higher your monthly bill (and the less interest you pay over time). In 2022, the average new car loan term for buyers with prime credit ratings was just over 71 months, and terms of up to 84 months are becoming more common.
These extended loan terms mean buyers pay more for interest, which over time could lead to the buyer owing more on the car than it’s worth.
More people can rely on credit leading to lower credit scores
As the economy continues to struggle, a Discount rate study shows that more people are carrying month-to-month credit card debt rather than paying off their balance in full. Currently, 46% of credit card holders in the United States are in debt, up from 39% last year.
Although consumers have no choice but to rely on credit for everyday purchases (and stretch those credit card payments as far as they can), carry a balance can hurt your credit score, limiting your ability to get a low-interest car loan. If you find that your credit score is a bit lower now than it was in the past, and you’re facing a higher interest rate than you’re used to, you may want to consider to add gap coverage when customizing your new auto insurance package.
The new car market should stabilize (eventually)
After a pandemic, semiconductor shortage, historic labor shortage and supply chain issues, automakers are finally signaling they could be reduce the bottleneck in the manufacture of new cars. As a result, some experts say the cost of new cars could start to rise. stabilize in 2023, and that the prices of some brands and models have already started to drop. Moreover, the Consumer Price Index (CPI) shows that from December 2021 to December 2022, the United States saw the smallest increase in new car prices since June 2021.
While all of this is good news for consumers, an unstable auto market could put new car buyers in a precarious position. For example, let’s say you financed a new vehicle today at 5% above market value. Then new car prices drop to baseline in 2024. This price stabilization, combined with depreciation and possibly a higher than normal interest rate, could mean you are now upside down on your loan. If you are involved in an accident and your vehicle is totaled, you may have to pay heavy expenses (unless you have gap insurance).
The bottom line
We could hit the peak in new car prices as supply chain issues ease, allowing automakers to meet consumer demand. However, you are still likely to pay more for your new vehicle today than before the current inflationary period. The added pressures of a tight economy could also cause new car buyers to accept less than ideal car loans, making it more likely that down the line they could owe the bank more than they’re worth. their vehicle. The Insurance Information Institute (Triple-I) states that, on average, gap insurance adds $20 per year to your car insurance premium — a relatively low price to pay for additional financial protection on your new (and expensive) investment.
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