Calamity! Your car – your pride and joy, which you drove off the showroom floor 18 months ago – is gone, stolen from a supermarket parking lot while you were shopping. You insured it for its market value, as most people do, but you owe the bank thousands more than you’ll be paid out. Your only feasible option now is to buy a car of lower value with what you get from the insurance company, and carry on forking out to the bank.

There’s insurance to cover this type of situation, when your car is either stolen and not recovered or written off following an accident. Top-up cover, or credit shortfall insurance, is usually offered as an optional add-on to your vehicle cover when you buy a car. It pays out the difference between what your car is insured for and what you still owe the bank. And it doesn’t add much to your premiums.

Santam’s personal lines underwriting manager, Marius Neethling, says this type of cover has been available for many years. Most insurers and finance companies offer it as part of their vehicle cover or on their retail insurance lines.

WHO NEEDS IT AND WHAT DOES IT COVER?

Credit shortfall insurance is recommended if you buy a new car or a recent-model used car on hire purchase from a motor dealer. It may even be a condition of your contract with the institution providing the finance.

Vehicle financing, especially if your deposit is low, entails high finance charges, most of which comprise the interest on your loan over the repayment period. At the outset, depending on the interest rate and your deposit, you can owe the bank far more than the price of the car. This difference, between the car’s value and what you owe, is exacerbated by the fact that a car depreciates over time, taking its biggest knock in value (an estimated 15 to 20 percent), the moment you take ownership of it – that is, when it becomes a “used” car.

The cover is typically necessary for the first two years of paying off a loan on a vehicle.

Neethling says the cover applies to both new and used cars, “as long as the vehicle that is financed falls within a credit agreement as per the definition of credit agreement given in the National Credit Act. Clients need to understand what type of vehicle finance they have and whether the available insurance covers that or not. For example, if you bought a car with a personal loan, shortfall cover for the vehicle would not apply.”

Also, your vehicle must be comprehensively insured, Neethling says. Shortfall cover is not available to you if you only partly insure your car – for example, for third party, fire and theft.

He says that if, for some reason, your car is insured for less than its market value, the shortfall applies to the market value and not to the insured amount. For example, if you owe the bank R120 000 and your car is insured for R80 000 instead of its market value of R100 000, the policy will pay out R20 000 for credit shortfall cover (R120 000 minus R100 000), not R40 000.

Any instalments and interest in arrears will be also deducted from the amount of the outstanding hire purchase.

WHEN DOES IT PAY OUT?

The conditions under which shortfall cover pays out do not differ much among insurers. Santam, according to Neethling, “will pay this difference if we accept a claim for the vehicle being either, in our opinion, beyond economic repair following loss or damage; or stolen and not recovered within a reasonable period.”

WHAT DOES IT NOT PAY FOR?

Standard shortfall insurance will typically not cover extra expenses related either to your car finance or to your loss, such as the deposit you put down on the car or the excess on your car insurance policy. Importantly, it will also not cover the residual (balloon) payment to the financing institution, which many people opt for when financing their vehicles. This is the remaining amount you owe the bank at the end of the financing period, and it can be up to 40 percent of the price of your car.

However, insurers do offer add-ons that cover some of these amounts, if you are prepared to pay the extra. For a higher premium, Neethling says, Santam will cover your balloon payment, and its standard vehicle cover has an excess-waiver option. Other insurers offer bells and whistles such as deposit protection, and will even cover your loan repayments in the period between losing your car and the loan being settled.

Expenses typically not covered by shortfall insurance are:

* Unspecified sound equipment or accessories;

* Additional finance charges; and

* Any early-settlement penalties.

HOW MUCH DOES IT COST?

The top-up cover for a car bought without a balloon payment is relatively inexpensive. Santam’s premium is calcu-lated on the insured amount of the vehicle. If you wanted it to cover your balloon payment (up to a maximum 40-percent balloon amount), it could cost much more, over and above your car insurance premium.

WHEN TO CANCEL YOUR COVER

As you pay off your loan and the amount you owe decreases, so your shortfall amount will decrease, until you reach a break-even point when you no longer need the extra cover. If you don’t want to pay for something you don’t need, it’s important to monitor the benefit, Neethling says.

Some people, he says, take out the cover with their vehicle insurance when they buy a new car, and then forget about it, resulting in needless payments over what may be a long period. In fact, he says, you need to review both your vehicle cover and shortfall cover regularly, to ensure you are not paying too much for either. It is up to you, the policyholder, to do this – your insurer will not generally do it for you, although some insurers annually bring your vehicle cover (but not necessarily your shortfall cover) into line with its depreciated market value.

To determine if you have reached your break-even point, check the outstanding balance on your finance agreement and compare it with the market value of your vehicle, which you can obtain from your insurance company. Once the amount you owe is equal to or less than your car’s market value, you should cancel the cover.

EXAMPLE: SHORTFALL ON YOUR CAR FINANCE

You buy a car with the help of finance from a bank. The car’s price is R300 000, and you put down a |10-percent deposit of R30 000. The credit agreement is for R270 000, with interest at 10 percent a year and a 30-percent balloon payment (R81 000) after five years. Your repayments are R4 600 a month.

The car is written off 18 months later. Since it is covered at market value, the insurer pays out R200 000 (assuming the car depreciates 33.3 percent in 18 months, which is feasible). You owe the bank R225 000, including the balloon payment of R81 000. Therefore your shortfall is R25 000. This assumes no finance charges apart from interest and no early-settlement penalty.

Your credit shortfall policy (with balloon payment cover) will pay out the R25 000.

THE INSURED VALUE OF YOUR VEHICLE

According to Rory Judd, head of online marketing at insurer MiWay, when insuring your vehicle, you have a choice of covering it for retail value, trade value or market value. The retail value is the average of what the same vehicle is currently selling for at car dealerships, and is the highest price you can insure it for. The trade value is what you would get for your car if you traded it in. The market value, or fair value, is halfway between the retail and trade values. The value of your car further depends on the condition and mileage on the car, Judd says.

THE HIGH COST OF DEPRECIATION

Depreciation is the largest expense you will incur over a five-year car ownership period, according to national car sales website Cars.co.za. In fact, it says that, generally, after five years, the car that you bought new will be worth about half of what you paid for it.

Most cars depreciate at a rate of 15 to 20 percent a year, with the most severe drop in the first year of ownership, Cars.co.za says. The rate of depreciation decreases as the car gets older.

Cars.co.za gives the example of a BMW 3-series bought in 2012 for R363 052. In the first year it loses 15 percent of its value, in the second year 13 percent, third year 10 percent, fourth year nine percent, and fifth year eight percent. After five years, the car’s resale value is R202 292, with the total loss due to depreciation amounting to R155 197.

“BMW is considered a luxury brand and holds a strong position in the market. The depreciation on a BMW is therefore generally considerably less when compared with other brands,” Cars.co.za says.

“To avoid the brunt of depreciation, consider buying a used car with low mileage,” the site says.

You also need to check that your car is not over-insured, by reviewing your vehicle policy once a year.

Many factors influence a car’s rate of depreciation, Cars.co.za says. These include:

* Make. Reputable car brands with notable track records hold value better over time.

* Model. Popular models generally have a lower rate of depreciation.

* Age. New cars generally lose value faster than older cars.

* Valid warranty. If you sell a car that is still within its warranty period, the resale value will be higher.

* Accident history. Cars that have been in accidents have considerably lower resale values.

* Colour. Cars in neutral colours, such as black, white or silver, tend to have higher resale values.

* Added features. Comfort and safety features, such as central locking, alloy wheels, CD/MP3 player, navigation equipment and anti-lock braking system improve a car’s resale value.

* Fuel consumption. Cars that are light on fuel tend to have higher resale values than gas guzzlers.

You can’t avoid depreciation, but you can reduce it, Cars.co.za says. It suggests that you:

* Keep your car clean and well maintained and serviced.

* Try to keep your mileage as low as possible.

* Park your car in a garage or, if you don’t have a garage, consider buying a cover for protection against the elements.