What is gap insurance?
Gap insurance is an optional insurance coverage for newer cars. It is normally added on to your existing collision insurance policy. Gap insurance covers the difference between what you still owe on your car and how much the car is actually worth if you are involved in an accident and your car is considered a total loss.
For many drivers, a standard insurance policy provides enough protection to cover the cost of repairs or replacement if their car is damaged, totaled or stolen.
However, if you own a new vehicle, you should consider that if your car is totaled, or declared a total loss, after an accident, your car and the car’s actual cash value is lower than the amount you owe on your loan, that difference, or “gap,” will not be covered by insurance. The insurance company is only required to pay the fair market value or actual cash value of your vehicle; not the balance of your loan.
Your car loses value the moment you drive it off of the lot. Some vehicles are known to lose as much as 30% within the first few months of purchase. By the second year, the value of most cars depreciate by 20%.
Do I need gap insurance?
Say that you finance a vehicle with a total loan amount of $40,000. Once you drive it off of the lot, the value of your vehicle immediately decreases. Your car may now only be worth $32,000, but your loan will still be $40,000.
If you are involved in a car wreck and your car is declared a total loss, your insurance will only pay the $32,000 that the car is actually worth. Without gap insurance, you will be responsible for paying back the $8,000 balance on your loan.
Your insurance company doesn’t care how much you owe on your auto loan – they will never pay out more than the car is actually worth. You will be left to foot the difference if you do not have Gap insurance.
Should I buy gap insurance?
You may want to consider purchasing gap insurance if:
- You are buying or leasing a new or slightly used vehicle of significant value.
- If you plan on taking out a long-term auto loan. Chances are you’ll end up “upside down” on the value of your car.
- You are financing a new or used vehicle without a large down payment, creating a “gap” between your vehicle’s actual value and your loan amount.
- You think you would have trouble coming up with the funds to cover the “gap” in case of an accident.
Keep in mind that gap insurance policies are typically only needed for the first few years of your auto loan. Eventually, your car will match the market rate and you’ll earn some equity on your vehicle.
So here’s a tip if you’re considering purchasing Gap insurance for your new vehicle:
Look outside of the car dealer! Most people think that the car dealer is the only source, but you may actually be able to find better rates by shopping around. Credit unions, banks and your own insurance company may also offer this service at a lower price.