Bought a Car in the Last Few Years? You May Really Need This Kind of Insurance

Buying a car is one of the biggest purchases many people make during their lifetimes. Since a car is a really valuable asset, it's important that every motorist who owns one has the right auto insurance coverage to protect it.

For those who purchased a vehicle recently, and who got a car loan to do it, there's one particular type of insurance that may be especially essential. Here's what it is -- along with some details about why buying this kind of coverage could be so necessary right now.

Drivers who bought vehicles in the last few years could be in a negative equity situation

Ideally, every motorist would pay for their vehicle out of their bank account to avoid interest charges. But in reality, most people can't do that, and instead take out an auto loan to purchase a vehicle.

This can become a problem if vehicle prices fall quickly and they have long-term car loans or they make low down payments. A driver who didn't put much down on a car, or one who is paying off the loan very slowly over time, doesn't have much equity in the vehicle. Equity is the part of the car owned by the driver, rather than by the auto loan lender.

If a driver doesn't have equity, they may owe more on the loan than the car is worth. This is called having negative equity. And many people who bought recently are faced with this situation because of past and current market conditions.

See, during the heart of the COVID-19 pandemic, new and used car prices surged due, in part, to supply chain disruptions and issues with semiconductors. So, anyone who had to buy a car then had to pay a lot of money for it. Then, used car values fell about 16% from pre-pandemic highs, which means many borrowers who essentially overpaid during the pandemic shortages may now find their car not worth nearly as much as they owe on it.

This helps to explain why new car buyers have actually had a surge in negative equity, with those turning in their vehicles owing $5,820 more than the car is worth on average, according to Bloomberg. Those who bought cars in recent years and who are keeping them, rather than trading them in, may also be underwater on their car loan (owing more than it's worth) by a similar amount.

Drivers with negative equity need gap insurance

Any driver who owes more than their car is worth could face a big problem if they are involved in a motor vehicle accident that results in the car being declared a total loss. They could also have a problem if their car is stolen and not recovered or is otherwise damaged beyond repair.

The issue is, when an insurer has to pay for a car that needs to be replaced because it can't be repaired, the insurer only pays the fair market value of the vehicle. But the full amount of the car loan has to be repaid. A driver who bought a car recently when prices peaked could owe a lot more than the current market price, so they could find themselves stuck paying thousands off on a car loan for a vehicle they don't even have any more.

Gap insurance, which is an optional add-on from most insurers, helps motorists avoid this fate. When purchased before a covered loss, this kind of add-on policy will pay the difference between what's owed and what the insurer pays based on what the car is worth.

Some lenders require gap insurance, so many motorists may already have coverage. But those who don't -- especially if they purchased a car in the recent past -- should get gap insurance if there's even a chance that they could get less than the current loan balance paid out after a claim.

Adding this coverage is usually as simple as making a phone call to the insurance company to request it, and paying the extra premiums, which could be as low as $36 annually. Call today before an accident happens or a car is stolen and it's too late.