There are two major purchases you will make in your lifetime for which entering into debt can be justified: one is the purchase of property and the other is the purchase of a car. If you buy a car through bank finance, you will find that taking out comprehensive car insurance is compulsory. What many consumers fail to take up, however, is the credit shortfall or top-up insurance that they are typically offered when they are insuring a new car.

What is credit shortfall insurance?

Credit shortfall insurance is a value-added product, which is not compulsory. This is insurance that covers the difference between the amount that your car is actually insured for and the amount of money you owe the bank, including any interest charges. Rory Judd, MiWay’s head of online marketing says if a new car is stolen or written off in an accident, there is often a gap between the insurance payout and the amount owed to the bank, leaving you owing money on a car you no longer have.

Why you need credit shortfall cover

Your car insurance policy will typically cover the retail or market value of your vehicle. The retail value is the amount you paid the dealer for your car. The market value is the amount that any reasonable buyer could be expected to pay for your car based on the mileage, condition and age of the car. However, both these values are often far less than the total amount you owe the bank when you take out vehicle finance. For example, when you buy a brand-new car, the market value of the car drops the minute you drive it off the showroom floor.

For example, Anne buys a car for R200 000 and finances it through Wesbank. She insures the car with MiWay for its retail value and takes credit shortfall insurance as an optional add-on. The car is stolen months later when the retail value is R150 000 but Anne still owes Wesbank R180 000. The shortfall amount is R30 000, which is covered by the credit shortfall add-on. If she did not take credit shortfall cover, Anne would have had to cover this amount from her own pocket.

Johan van Greuning, head of Standard Insurance Limited, says if your car is written off or stolen before your finance agreement is paid off, the full outstanding amount becomes immediately payable to the bank because the underlying security asset (your car) no longer exists. “You can ask the bank to re-spread the debt but as an unsecured loan, the finance agreement will change and is unlikely to be spread over a period longer than a year,” he says.

What you need to know

Credit shortfall insurance is particularly important in the first few years of your vehicle finance agreement. Van Greuning points out that the breakeven point between the value of your car and the amount you owe the bank is usually two-and-a-half to three years into the finance agreement. Once you have passed this point, you can cancel the credit shortfall cover.

What cover is excluded from credit shortfall insurance

Credit shortfall insurance will differ between insurers so you should read your insurance agreement carefully. Judd says the following costs are typically not included under credit shortfall cover:

• Unspecified sound equipment or accessories
• The excess payable on your claim
• Arrear instalments and the interest that may have accumulated on these instalments
• Additional finance charges
• Any early settlement penalties