Of payment schedules and gap insurance

To recap, we’ve been talking about my friend “Irene,” who bought a car she couldn’t afford, and then the dealer talked her into a second deal …. to pay even more money for a less valuable used car!

When I looked at Irene’s paperwork for the second transaction, here is what I saw.  This Retail Installment Sale Agreement contains key disclosures required by a law called the Truth in Lending Act, or TILA.

Irene’s second contract

The first thing I noticed was the Total Sale Price, defined as “the total cost of your purchase on credit, including your down payment.”  It was more than $3,000 higher than the figure on the first contract.  That told me immediately that the dealer had taken advantage of Irene.  She was trying to downshift, yet wound up in a more expensive deal.

Then I looked at the Payment Schedule.  Irene was looking to reduce her payment below $300.  The monthly payment shown on this contract is $299.98.  How did the dealer get the payment to be a hair under $300?  By stretching out the time to 78 months — that’s six and a half years.  Irene never noticed that her new contract was three months longer than the first one.   And the first one, at 75 months, was plenty long to begin with.

There’s no law regulating how long an installment sale can be for.  Dealers know that customers often just look at the monthly payment and don’t consider the consequences of having a car not paid off for many years.  Long contracts cost you money.

When it takes so long to pay down the debt, it means that you owe more than the car is worth for a long time.  If during that time you get into a serious accident,  such that your insurance company “totals” the car, you’ll still owe money to the finance company.  That’s bad for you and maybe worse for the finance company.  That’s why dealers urge you to buy gap insurance.

Though often written as “GAP,” like an acronym, “gap” is just a description of what is being insured:  the “gap” between the car’s value at the time of an accident, which is the most that a collision policy will pay, and the remaining indebtedness that you owe on the car.  Irene’s contract calls for her to pay $700, plus the cost of financing that $700 over 6-1/2 years, for gap insurance.

Is gap a smart purchase?  It’s hard to say.  How long will the coverage last?  Will you be insured for as long as there is a gap, or only for a couple of years?  The dealer dictates the price for this product because it’s not really practical for a consumer to buy it from another source. Most such products involve a high markup by the dealer.

Another way to approach this question is:  if gap insurance seems necessary, think about whether you can reduce or eliminate the gap to the point where you can self-insure against this risk.  Maybe you’re buying too expensive a car.  Maybe the interest rate is more than you need to pay.  Maybe you should increase your down payment,  or insist on a shorter period of payments even though that means a higher monthly payment.  Maybe you have, or can start, a savings account, to pay off any gap in the unlikely event of having your car totaled in an accident.

Cars are expensive enough; what’s really awful is to have a deal padded with financing charges.  Under TILA, certain kinds of insurance, including gap, are not counted as part of the Finance Charge if you are given the choice whether or not to buy them.  But conceptually, gap insurance is part of the cost of credit.  If you can buy a car without buying gap insurance, you will save money in the long run.


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