Gap Insurance – What is gap Insurance?
When you owe money on a depreciated vehicle, protect yourself financially.
Gap insurance is a sort of auto insurance that automobile owners can buy to protect themselves from losses that can occur when the amount of compensation received from a total loss does not entirely cover the amount owed on the vehicle’s finance or lease agreement. This occurs when the balance outstanding on an automobile loan exceeds the book value of the vehicle.
Gap insurance is a type of extra auto insurance that covers the difference between the insured value of a vehicle and the loan or lease debt that the owner must repay.
If your vehicle is totaled or stolen before your loan is paid off, gap insurance is required to cover the difference between your auto insurance payout and the amount owed on the vehicle.
Consider John’s automobile, which is valued at $15,000, as an example of gap insurance at work. He does, however, owe a total of $20,000 in car payments. If John’s automobile is fully destroyed in an accident or stolen, his car insurance coverage will compensate him for $15,000. However, because John owes the auto loan business $20,000, he will still be $5,000 short, despite the fact that he no longer possesses a car.
If John purchases gap insurance, the $5,000 “gap,” or the difference between the money received from reimbursement and the amount still outstanding on the car, will be covered.
• You financed a vehicle with little or no down payment: You’ll be upside down on your car loan the instant you drive it off the lot if you don’t make a hefty down payment. It could take several years for the loan amount and the car’s actual value to equalize.
• You traded in an upside-down vehicle: Unless you pay the difference up front when trading in an upside-down car, the dealership will add what you still owe to the loan balance of the new car.
If your automobile is wrecked or stolen, this additional debt could haunt you.
• You purchased a car with a low resale value: If you purchased a car with a low resale value, you’d be upside down without a hefty down payment. Consider 25% or more when we speak significantly.
• You intend to rack up the miles quickly: Few things depreciate a car’s worth faster than a lot of driving. The quicker you drive, the faster your car’s value depreciates, and it’s likely that you’ll be losing the value of your automobile faster than your payments can keep up.
• You’ve taken out a long-term auto loan (greater than 60 months): A long-term loan takes longer than typical to reach the break-even point, which is the point at which your loan balance and the value of the car begin to equalize.
When you buy or lease a new automobile or truck, the vehicle’s value begins to deteriorate the moment it leaves the dealership. In reality, most cars lose 20% of their value in the first year. Standard auto insurance policies cover the depreciated worth of a car—that is, a standard policy covers the vehicle’s current market value at the time of a claim.
• You’ve taken out a long-term auto loan (greater than 60 months): A long-term loan takes longer than typical to reach the break-even point, which is the point at which your loan balance and the value of the car begin to equalize.
How does gap insurance work?
When you buy or lease a new automobile or truck, the vehicle’s value begins to deteriorate the moment it leaves the dealership. In reality, most cars lose 20% of their value in the first year. Standard auto insurance policies cover the depreciated worth of a car—that is, a standard policy covers the vehicle’s current market value at the time of a claim.
If you finance the purchase of a new car and put down only a tiny deposit, the loan amount may exceed the market value of the vehicle in the early years of ownership.
Gap insurance covers the difference between what a vehicle is currently worth (which your normal insurance will pay) and the amount you owe on it in the case of an accident in which it is significantly damaged or totaled.
When you may require gap insurance
It’s a good idea to think about getting gap insurance for your new automobile or truck if you:
• Paid less than 20% down payment
• Financed for 60 months or more
• Leased the vehicle (usually, gap insurance is required for leases)
• Purchased a vehicle that depreciates faster than the average
Where can you acquire gap insurance?
On your new vehicle, your auto dealer may give you gap insurance. However, most car insurers provide it as well, and they usually charge less than the dealer. Adding gap insurance with accident and comprehensive coverage to most auto insurance policies adds only about $20 to the annual rate.
If you’re financing a vehicle, your lender may need gap insurance for certain types of automobiles, trucks, or SUVs. This includes luxury sedans, SUVs, and certain other types of SUVs, which may degrade and lose value at a higher rate than typical.
When you buy or lease a vehicle, some dealers provide gap insurance.
However, it is critical to compare the cost to that of regular insurers.
In the early years of an automobile’s life, it’s pretty easy for a driver to owe the lender or leasing company more than the car is worth. A small down payment and a long loan or lease time will suffice, at least until your monthly payments accumulate enough equity in the car.
When it comes to filing claims and vehicle values, equity must equal the car’s current value. If the automobile is totaled, your usual insurance will pay that value, not the price you bought. The issue is that cars depreciate rapidly in their first few years on the road.
In reality, the average car loses 10% of its value in the first month following purchase.
If your automobile is totaled, your coverage will not cover the cost of replacing it with a brand-new vehicle. You’ll get paid the amount that a car similar to yours would sell for on a used-car lot. This is referred to as the vehicle’s actual cash worth by insurers.
That particular gap is not covered by gap insurance. The rewards are based on actual cash worth rather than replacement value, which can help to reduce your financial losses.
Gap Insurance for Automobiles Example
Assume you bought a new car with a sticker price of $28,000. You put down 10%, lowering your loan to $25,200. You received a five-year auto loan. For the purpose of simplicity, assume you get one of those 0% new-car financing options, with a monthly payment of $420. You’ve paid $5,040 after a year. You are still owing $20,160.
One year later, the car is totaled, and the insurance company declares it a total loss. Your auto insurance policy states that you are owed the full current value of the vehicle. Your car, like the average, is now worth 20% less than you purchased for it a year ago. That’s $22,400.
Your collision coverage will compensate you for the remaining balance on your auto loan, leaving you with $2,240 to put down on a replacement vehicle.
But what if your vehicle is one of the versions that does not keep its value as well? Assume it has depreciated by 30% since you purchased it. Your insurance check will be $19,600 in that situation. You owe $560 to your lender. And you still need a new automobile, which is why car gap insurance is essential.
Here are two samples of what you might pay with or without automobile gap insurance.
You may have heard the phrase “upside down” in relation to mortgage debt. Whether the thing being financed is a house or a car, the premise is the same:
The financed item is currently worth less than the amount of the loan used to obtain it.
This isn’t as bad as it appears. If you put a tiny down payment on a house or automobile and pay the rest in small monthly installments over five years or more, you don’t immediately own much of it free and clear. Your ownership portion grows as you pay down the principal, while your debt reduces.
Gap insurance is required to cover the shortfall, so you are not liable if the car is totaled.
If you don’t have gap coverage
Total Loan Amount Owed $20,160
Collision Insurance Payout $19,600
Shortfall $-560
(Gap Payout) (0)
Your Out-of-Pocket Cost $560
Total Loan Amount Owed $20,160
Collision Insurance Payout $19,600
Shortfall $-560
Gap Payout $560
Your Out-of-Pocket Cost $0
Car Gap Insurance May Be Necessary If…
According to the Insurance Information Institute, you should think about getting gap insurance for your new car or truck if you:
• Paid less than a 20% deposit
• Financed for at least 60 months
• Vehicle was leased (carrying gap insurance is generally required for a lease)
• Purchased a vehicle with a higher depreciation rate than the average
• Transferred negative equity from an existing auto loan into the new loan
In these cases, gap insurance could protect you from potentially disastrous financial implications if the vehicle is deemed a total loss.
If you got gap insurance, keep track of your loan balance and cancel it whenever you owe less than the book value of your vehicle.
You Might Be Able to Avoid Gap Insurance. If…
You almost surely need collision coverage if you’re still paying off your car. Without it, you’d be playing with fire, and in any case, collision coverage is probably required by the conditions of your loan or lease agreement.
• You put down at least 20% on the car when you bought it, so there’s little chance you’ll go upside down on your loan, even in the first year or two.
• You have paid off your car loan in less than five years.
• The car is of a make and model that has traditionally held its worth better than the norm.
It’s a good idea to check the National Automobile Dealers Association (NADA) guide or Kelley Blue Book on a regular basis to see how much your automobile is worth. Compare it to the outstanding sum on your loan. If your loan balance is smaller than the value of your car, you won’t have to worry about a gap.
Gap Insurance vs. Replacement Value Insurance
Some car insurance firms provide replacement value insurance, which is often known as new car replacement insurance. If your vehicle is totaled, this option compensates you with money for a brand-new car of the same make and model (less your deductible) rather than the depreciated worth of your totaled vehicle. This form of insurance can be a good substitute for gap insurance.
To qualify for this sort of insurance, your vehicle must fulfill certain age and mileage limits. It’s also usually only accessible if you get collision and comprehensive coverage. However, if you qualify, this form of the policy can totally replace gap insurance.
The Benefits and Drawbacks of Car Gap Insurance
A new car is a costly purchase these days. The average new auto loan is more than $32,000. Now, the average loan period is 70 months.
Even if your lender allowed it, you’d never consider skipping collision insurance on that car. However, you should consider gap insurance to supplement your collision insurance during the time when you owe more on the car than its actual cash value. If your automobile is totaled, your collision insurance policy will cover the cost.
This is especially prevalent in the first few years of ownership if you put down less than 20% and extended the loan payback term to five years or more.
A short glance at a Kelley Blue Book will reveal whether you require gap insurance. Is your car currently worth less than the loan balance? If this is the case, you will require gap insurance.
What Does Gap Insurance Cost?
According to the Insurance Information Institute, you may add gap insurance to your ordinary comprehensive auto insurance coverage for as little as $20 per year.
However, your cost will vary according to the standard insurance laws. That is, your state, age, driving record, and car model all play a role in pricing.
A large insurer will normally charge 5% to 6% of your auto insurance policy’s collision and comprehensive premiums. For example, if you pay $1,000 per year for those two coverages combined, you’ll only have to pay an extra $50 to $60 per year to secure your loan with gap insurance.
According to Bankrate, going through an insurer for gap coverage is usually less expensive than going through a dealer or a lender.
Dealer Choice
Before you drive off the lot, the auto dealer will almost certainly try to sell you gap insurance. In fact, some are obligated to provide it by state law.
However, dealers generally charge significantly more than the main insurance carriers. A dealership would often charge you a set sum of $500 to $700 for a gap policy. As a result, it pays to look around, beginning with your existing auto insurer. Many insurance companies will let you add gap insurance to your existing motor policy.
Another benefit of choosing a well-known carrier is that it is simple to discontinue the gap coverage when it no longer makes financial sense.
Is gap insurance necessary?
If there is ever a time when you owe more on your automobile than it is currently worth, gap insurance is well worth the money.
If you put down less than 20% on a car, you should purchase gap insurance at least for the first couple of years. You should owe less on the car than it is worth by then. If the automobile is totaled, you won’t have to pay the difference between the insured value and the amount you owe a lender out of pocket.
If you take advantage of a dealer’s periodic car-buying incentive, gap insurance is very valuable. If you receive a bargain with a modest down payment and three months “free,” you’re almost certainly going to be underwater on that loan for a long time.
Is car gap insurance necessary if you have full coverage?
Full coverage is provided by comprehensive auto insurance. It includes collision insurance, but it also covers any unforeseeable disaster that can ruin an automobile, such as vandalism or a flood. However, it only pays the actual cash value of the car, not the price you paid for it or any remaining loan balance. The difference is covered by gap insurance.
As a result, gap insurance is required if there is a difference between what you owe and what the automobile is valued at on a used-car lot. That is most likely to happen during the first few years of ownership when your new car depreciates faster than your loan balance shrinks. When your loan debt is low enough to be fully covered by a collision insurance payment, you can cancel the gap insurance.
What is the purpose of gap insurance?
Consider it supplementary insurance for your car loan. If your automobile is totaled and your comprehensive auto insurance coverage covers less than what you owe the lender, the gap policy will compensate you.
How can I obtain gap insurance?
The simplest—and most likely cheapest—way is to ask your auto insurance company if it is possible to add it to your existing coverage. You may compare rates online to ensure you get the greatest bargain.
The auto dealership will almost surely give you a gap coverage, but the cost will almost certainly be greater than what a large insurer will provide. In any event, double-check to see if you already have gap insurance on your vehicle. Gap coverage is frequently included in the price of auto leases.
Do you require gap insurance after purchasing a car?
Sometimes. Your best bet is to contact your auto insurance provider and inquire about adding it to your existing coverage. Your insurer should be able to tell you what your alternatives are and how much it will cost to add gap coverage. Compare the best vehicle insurance prices to find the best option.
Unless required by the terms of your lease or loan agreement, gap insurance is normally optional insurance coverage. Nonetheless, if you recently purchased a new car, it may provide you with a significant piece of mind.
Car gap insurance is beneficial for those with large negative vehicle equity. This includes drivers who put down little money or have a long loan payoff time. If you want to save money on auto insurance, one way to do it is to avoid paying for gap insurance when you don’t need it.
