Totaled a Car You're Still Paying Off? Here's What to Do

When it comes to insurance, it pays to plan for the worst.

Imagine you're on your way to work on a snowy day. The highway is packed, but most drivers are taking it easy. Suddenly, a giant SUV slams into the car behind you, pushing your car into the vehicle ahead of you, and a chain reaction begins. When it's all over, your car looks like an accordion, and your insurance company totals the vehicle.

When is a vehicle considered "totaled?"

A car is considered a total loss, or "totaled," when the insurance company decides it's not worth the money it will cost to fix. Many states have a formula insurers use to determine when to declare a vehicle totaled.

For the sake of this illustration, assume that your car has an actual cash value (ACV) of $10,000. ACV is not the amount you paid for the vehicle or even the amount still owed on the auto loan. It's the amount the car would be worth if you sold it for cash. You can find that number on Kelley Blue Book's website, for example.

In your state, let's say that a car is totaled when the cost to make repairs exceeds 80% of the vehicle's value. Unfortunately, the insurance company estimates it will cost $8,500 to make all necessary repairs. Since the car has an ACV of $10,000, the cost of repairs exceeds 80%, and the vehicle is deemed totaled.

What happens if it's totaled, but I owe more than fair market value?

Once a car is deemed a total loss, the insurance company will cut you a check for the car's ACV. In return, you provide the insurer with the car title.

Unfortunately, you still owe $15,000 on a vehicle worth only $10,000. You provide the insurance company with the title to the car, and the insurance company cuts a check for $10,000 and sends it directly to the lender. You're now on the hook for the balance of $5,000.

Insurance companies normally auction off totaled cars to car dealers or scrap companies that want them for parts. If you decide to keep the totaled car and make repairs yourself, you'll have to pay the insurance company the amount it would have made by auctioning it off.

Gap insurance

While you can negotiate with your lender to decrease your balance, you're unlikely to be successful. And if the lender does settle for less than you owe, the settlement will show up on your credit report and cause your credit score to drop.

The best way to avoid this situation is to carry gap insurance. Gap insurance is an optional coverage that pays off your auto loan when your car is totaled or stolen and you owe more than the ACV. In the scenario above, the full $15,000 you still owe on the vehicle would be paid off instead of only $10,000.

When buying a car, it's common for the dealership or lender to ask if you'd like to buy gap insurance and roll it into the loan amount. While this may seem like a convenient way to buy coverage, it's likely to be the most expensive. Once it becomes part of your loan, you'll pay interest on the gap coverage.

A better option is to add gap coverage to your new or existing insurance policy. The add-on is likely less expensive through your insurer, and you won't have to pay interest on the coverage. If you need clarification on whether you currently carry gap coverage, call your agent or insurer to learn how much it would cost to add it.

If you've just been in an accident and owe more on your vehicle than your insurer says it's worth, we realize that advice to buy gap insurance comes too late.

However, it is possible to advocate for yourself, even after the insurance company's decision comes in. If you believe that the ACV assessment is too low, Kelley Blue Book advises that you negotiate the payout. You do that by presenting evidence as to why your car is worth more than the insurer says. For example, if you've upgraded basic components, added expensive wheels, or in any way enhanced the vehicle, let the insurance company know.

Hopefully, you'll never need gap coverage, but it's nice to know it's there if you do.