The hidden risks of car financing: understand credit shortfall insurance

14 Nov 2024

If you don’t take shortfall cover, you could lose your car and still owe the bank a bundle.

When you buy a car that is financed by a bank, insurance is compulsory. However, the bank and the dealership might not tell you about the importance of credit shortfall insurance, which is not compulsory.

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 a reasonable buyer could be expected to pay for your car based on its mileage, condition and age.

However, both these values are often much less than the total amount you owe the bank. Credit shortfall cover, an insurance add-on, covers the difference between the insured value of your car and what you owe the bank.

For example, a 2023 Suzuki Swift 1.2 GL Auto is listed on Autotrader at R249,900. That’s the retail value and usually the amount the car will be insured for.

The problem is that if, like most people, you are financing it, you owe the bank a lot more. The WesBank calculator shows that if you have no deposit and you finance the car over 72 months at an interest rate of 13%, the total cost of credit is R367,902.60.

If you insure the car for retail value and it gets stolen within a few months, the insurer would cover R249,900 and you would still owe the bank R118,002.60.

Lebogang Gaoaketse, head of marketing and communication at WesBank, says the amount owed would be due immediately.

“If the customer is not in a position to settle the account, we recommend that the customer enters into a payment arrangement with us,” he says.

Two consumers who complained to the Financial Services Ombud in the past year both had issues involving shortfall cover.

Case study one

On 12 February 2017, the complainant’s Toyota Hilux was stolen while he was on holiday. His business tools and several personal items, including his wife’s ring, were stolen. When he lodged a claim, he was informed that although the vehicle claim would be paid:

There would be an additional theft excess as the vehicle had not been fitted with a tracking device.

The vehicle finance account would also not be fully settled as the outstanding balance was more than the vehicle’s retail value as per the insurance policy.

His wife’s wedding ring would also not be paid for as it was not listed on the policy.

The complainant approached the Financial Services Ombud, asking to be paid R204,164.48 for the ring, the theft excess and the shortfall cover.

In its response, the insurer said that when the Hilux was added to the insurance policy on 13 January 2017, it had the same car hire and excess waiver benefits as the vehicle it replaced. On 26 January 2017, the insurer emailed the complainant a copy of the policy schedule along with a “vehicle template” and asked him to complete the outstanding information and send it back. The form included the shortfall option, which was left blank. The vehicle template also stated that the vehicle was high-risk and had to have a tracking device installed.

The ombud found that there was no evidence of the insurer giving the complainant an explanation of the tracker requirement or alerting him to this important requirement.

“Emailing a standard template was not reasonable or adequate… in terms of the code,” the ombud’s annual report says. The General Code of Conduct for Authorised Financial Services Providers and Representatives places a duty on providers to give a reasonable and appropriate general explanation of the nature and material terms of a contract.

The ombud said the insurer specifically needed to draw the complainant’s attention to the fact that a vehicle tracker was required. However, because shortfall cover is an optional product and not a material term of a contract, the insurer was not held to be responsible for the complainant not choosing such cover.

The wedding ring was not covered because it was not specified in the insurance policy.

The ombud recommended that the insurer pay the theft excess of R45,012 with interest of 11.75% a year from the date of the loss.

Case study two

In the second case, the complainant’s car was written off in an accident and the insurer settled the claim for the car’s retail value. However, this was not enough to settle the outstanding balance owed to the bank, and the complainant said he was never advised about the shortfall cover option.

During the sales call, he had requested the highest cover because the vehicle was financed. The insurer’s representative confirmed that the complainant had been provided with the best cover and that the vehicle would be covered if it was written off after an accident.

This statement strongly implied that the complainant would be covered in full, including shortfall cover. The representative specifically stated that the customer would be covered if the vehicle was written off.

In this case, the ombud found that the complainant had not been obliged to raise the question of shortfall cover, as specific product knowledge of this nature was within the representative’s knowledge and expertise, not the consumer’s.

The ombud’s office said a reasonable representative would have advised the complainant of shortfall cover. “With the adequate information provided by the complainant, the representative was well informed that the complainant required full and adequate cover, including shortfall cover, and should have explained this… in a manner that avoided uncertainty. There is a high probability that the complainant would have accepted the shortfall cover, and the claim would have been paid,” the ombud’s report says.

The insurer agreed to settle the shortfall amount of R72,671.77. DM

This story first appeared in our weekly Daily Maverick 168 newspaper, which is available countrywide for R35.

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Case study one

Case study two