My 2017 Chrysler was totaled after a tree fell on it during a tornado. My insurer paid me $9,300 in actual cash value — but I still owe $12K on my auto loan. What now?

Insurers pay only fair market value

Your auto insurance is supposed to protect you against financial loss if weather or an act of God renders your car a write-off.

However, insurers only pay the fair market value on your vehicle minus your deductible. The fair market value is the amount the car is worth when declared a total loss. In many cases, that value is far less than what you owe if you have a car loan.

This can happen for a few reasons, including long auto loan terms that leave you paying off very little principal, and low-down-payment vehicle loans. Used car prices have seen a 19% drop since 2020, while new cars are already known for losing value as soon as they're driven off the lot.

With so many potential ways to end up owing more than the car is worth — or being underwater on your car loan — it's not surprising that around a third of Americans who have auto loans find themselves in this situation. For many, the gap is big between what they owe and the car's worth. Auto industry resource Edmunds reported that more than 1 in 5 people trading in their vehicles owe at least $10,000 more than the car is worth.

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What can you do if you don't get the money you need?

When your car is declared a total loss after a weather event or is destroyed for another reason covered under your policy, you'll need a plan of attack for your auto loan.

Ideally, you'll have gap insurance that will cover the losses. Gap insurance is available from any dealer or an auto insurer. Some lenders require it. The insurance protects you by paying the difference between what you owe on the car and what the insurer pays you for a total loss.

Unfortunately, you'll need gap insurance before a covered event that totals your car, though. If you didn't purchase it beforehand and you find yourself in a situation where you're left with a big bill even after getting an insurance check, it will be too late.

In these circumstances, your only real option is to pay off the loan balance. If you don't, the lender can repossess the totaled vehicle — but that typically won't cover any remaining costs, so the lender is likely to come after you to collect the rest of the money. You may be able to renegotiate a payment reduction if they fear that you won't pay at all, but this isn't always an option as settling your debt can damage your credit rating.

One last-ditch option is to check if any financial relief is available through FEMA. Help may be limited, so whenever possible, safeguard yourself before the worst-case scenario.

In hindsight, one option to avoid this situation in the future is to make a large down payment, buy an inexpensive used car and pay off your loan as quickly as possible so you reduce the threat of negative equity. That way, you can avoid finding yourself at risk of financial loss after a disaster claims your car.