Do I need shortfall cover on my car?

Most of us need a loan to buy a car. And as soon as you have a car loan, there’s a chance you might need shortfall cover to protect you in case your car is written off or stolen.

We know you’re probably thinking, “But I have comprehensive car insurance? Doesn’t that protect me?” Well, not always. Should your car be written off or stolen, the amount you still owe could be higher than the amount your car is insured for. Shortfall cover will protect you from having to pay the difference out of your own pocket.

What is shortfall cover?

Shortfall cover, also known as gap cover or top-up cover, bridges the gap between the money you still owe on your car, and the amount your insurer pays out ‒ which is based on the value of your car at the time of the claim.

Shortfall cover ensures that you don’t end up out of pocket if your financed car is written off or stolen.

But why would my insurance pay me less than what I owe on my car?

If your car is written off or stolen, depending on your insurer, you will be paid either market value, trade-in value or retail value. This amount could be much lower than what you still owe on your car loan and, of course, less than what you originally bought the car for.

The reason for the gap between what your insurer will pay you and what you own on your car loan is because of depreciation

As soon your car leaves the showroom floor it depreciates in value, and then continues to depreciate further over time.

Depreciation is the difference between the amount you paid for your car and the amount you get for it should you sell it or trade it in.

While the outstanding balance on your loan decreases with each monthly repayment you make, the rate at which the value of your car depreciates is highest early on in the loan repayment, particularly within the first three years of its life. Depending on their make and model, cars can lose as much as a third of their value in their first year, and as much as half their value in the first two years.

This graph shows the depreciation and amount owed on a car worth R250 000. If the car were to be written-off or stolen in the first three years of its life, the payout would be insufficient to repay the amount still owed on the loan.

So how do you figure out whether you need shortfall cover or not?

If you don’t have a car loan or you either bought your car for cash or you can afford to cover the shortfall, you don't need shortfall cover.

If you do have a car loan, the main thing that will determine whether you need shortfall cover or not, is how quickly you pay off your loan. So you might need shortfall cover if:

A balloon payment is a large lump sum that needs to be paid at the end of the repayment period. It lowers your monthly repayment, but it also slows down how quickly your loan reduces. So, if your car is written off, it’s likely that your insurance payout won’t be enough to cover your loan.

The bigger the upfront deposit you give, the smaller your loan will be. This usually means that the value of your car is higher than that of your loan. Whereas if you make a smaller or no deposit, the opposite is true — the value of your loan is likely to be higher than the value of your car, which will put you at risk for a shortfall.

Having a long repayment term means that your loan amount decreases slowly, increasing the risk that the value of your car will depreciate quicker than your loan.

So the longer the term of your loan, the bigger the potential ‘gap’ between what you owe and the value of your car, and the greater the need for shortfall cover.

When leasing a car, you are essentially renting a car for a certain time period and for a certain amount of money. The risk is very similar to that of a balloon payment, so, if your leased car is written off or stolen, there is a risk of a shortfall.

If you have bought a new car, then you’ve probably heard that new cars decrease in value faster than older cars. For this reason, the risk of a shortfall will always be higher for new cars, as the gap between what you owe and what your car is worth can be quite significant, especially early on in your loan term.

Some insurers insure cars at market or trade value. At Naked, we insure cars at their retail value, but other insurers might also give you the option to insure your car at (the lower) market value or (the even lower) trade value. Opting for a lower insured value increases your potential for a shortfall.

The higher the interest rate charged, the greater the potential for a shortfall. Why? Because this reduces the rate at which you repay your loan and the slower you repay your loan, the greater the shortfall risk if something were to happen to your car.

This is a less significant factor than some of the others though.

If you are within the first 24 months of your loan term, and any one of the other factors above applies to you, you would most likely have a shortfall risk. The above rules aren’t foolproof, but they should give you a good idea of whether you need shortfall cover or not.

If you’re still unsure, check with your insurer or your finance house — they can help to point you in the right direction.

At Naked, all you have to do is tap a button and you’re covered for shortfall! It’s as easy as 1, 2, 3.

Shortfall cover starting from R30pm.