It’s an all-too-common scenario. A driver has just been involved in a total-loss accident in a two-year-old car that they bought brand new. They have a full-coverage collision insurance policy on their new vehicle so “no problem”, they think. They’ll just call their insurance broker, and their insurer will cover the full replacement cost of the totalled vehicle. Right?
But then our driver discovers a nasty fact; their insurance policy allows the company to make a depreciation deduction. This means that the driver will only be getting the market value of their car at the time of the accident. They thought they were fully covered, but now their bank is telling them that they still owe a $5,000 balance on the car loan for a vehicle they can no longer drive. And their insurance company won’t pay because the car’s value had steeply depreciated over the preceding two years.
The driver is now stuck with a massive bill on a car that no longer exists. And given the amount involved, their bank is almost sure to pursue collections of the debt in court if our driver fails to pay it, this could ruin their credit and open them up to nasty garnishment measures and even bankruptcy.
How could this terrible situation have been avoided?
Gap insurance is always a good idea when buying a new car
Unfortunately the above situation unfolds, in one form or another, thousands of times each year throughout Ontario and the rest of Canada. Well-meaning drivers who thought that their full coverage car insurance actually meant that they were fully covered are splashed in the face by the cold water of a different reality. Whenever your new car’s market value is less than the amount you still owe on your auto loan, you are on the hook for the difference.
This is why it’s strongly recommended that everyone who buys a new car on loan in Canada should also purchase gap insurance. In Ontario, this is accomplished through an OPCF 43 form, which can be added to your car insurance policy as an endorsement. Having the waiver of depreciation on your car insurance policy means your insurance company will cover the actual replacement value of your vehicle should it be stolen or involved in a total-loss accident. most companies will offer this optional coverage for 24 to 48 months on the purchase of brand new vehicles.
Why is the replacement cost such a big deal with new cars?
There are multiple good reasons to buy a new car. With improvements in safety and technology, new cars have never provided more protection for their occupants. For those who lack the mechanical skills and risk tolerance to keep unreliable older cars on the road, buying new is a great way to ensure that they’ll never have to worry about personal transportation.
Yet, buying new comes with a number of potentially serious risks of its own, which every new-car buyer should understand.
Many studies have confirmed that new cars can lose around 10 per cent of their value the second the new owner drives it off the lot. Most new cars will lose a total of around 20 per cent of their value in its first year of life. And it will lose roughly 20 additional per cent of its previous-year’s value each year following that for the first five years.
However, finance terms of up to 7 or even 8 years are becoming increasingly popular for Canadian drivers. What this means is that, depending on your circumstances, there is a very high probability that at some point in your new car’s life cycle you will end up owing significantly more on your auto loan than your car’s actual fair-market value. This is not an enviable position to be in. And it creates a permanent and large risk that could seriously imperil your finances at any moment. If your car is stolen or involved in a serious accident, even if it was another driver’s fault, you can easily find yourself paying off a large outstanding debt on a car that you no longer own or use.
A waiver of depreciation should also be used when leasing
Similar to buying a new car on a loan, in many cases, a leasing company will have the legal right to force you to continue making payments for the entire duration of your lease should the vehicle be stolen or involved in a badly damaging accident. Where the market value of the car plus the payments that you have already made is less than the vehicle’s replacement value, your leasing company may force you to perform on your lease even if you no longer have use of the vehicle.
Removing the deprecation deduction provides you with real protection
By adding the OPCF 43 endorsement to your policy you are ensuring that you will be truly protected in the event of a total loss to your vehicle.
When you purchase the waiver of depreciation with your car insurance, your insurance company will be forced to reimburse you for the full replacement cost of your vehicle. This means that there is no chance that you will be dragged into court and forced to make payments for months or years on a car that has long since been scrapped. It also means that you won’t find yourself in the terrible position of being forced to choose between enduring collection actions that could potentially ruin your credit or drive you into bankruptcy. You also will not end up being in the position where you cannot afford primary personal transportation because your monthly budget is being sucked dry by phantom car payments.
Gap insurance in Canada is the smart move
Yes, purchasing gap insurance will cost you an extra $50 to $100 per year, but it is well worth the expense! The cost will be added to your monthly car insurance payment, so you probably won’t even really notice the few extra dollars per month that you end up paying for it.
However, going without this important coverage for those who have recently purchased a new car can prove to be disastrous.
The most important thing is to fully understand your individual situation. Always reading the fine print on loan agreements and insurance policies and then carefully considering what coverage will best suit your needs is the best way to avoid nasty surprises when the unexpected strikes.
However, given the potential consequences of not buying adequate gap-insurance coverage, nearly everyone in Ontario who is buying a new car with the use of an auto loan is well advised to add the removing depreciation endorsement to their auto insurance policy.
It’s usually only a few dollars per month, but the peace of mind it can give you is truly priceless.
