Gap insurance is a type of optional coverage that protects you from incurring significant financial losses if your leased or financed car is stolen or totaled. While a fully comprehensive insurance policy covers losses up to the vehicle’s current value, it doesn’t necessarily cover the amount you paid for the car or still owe on the lease.
Gap insurance helps you pay off the remaining total of your auto loan if you still owe more than the vehicle’s depreciated value. The loan or leaseholder is only entitled to compensation if the remaining loan amount is more than the current book value of the car. Gap insurance is designed to be an add-on to collision and comprehensive coverage.
Vehicle Depreciation
An unfortunate aspect of car ownership is depreciation. Whether you buy a new or used vehicle, it loses value when you drive it out of the lot. Although there are exceptions, cars typically depreciate by around 20% after one year. They lose approximately 10% of their value every year after that, meaning they are likely to be worth half their original price after only 5 years.
Most auto insurance policies only cover expenses up to the depreciated (or current) value of the car at the time of a claim. If you finance or lease a vehicle, you may only need to pay a minimal down payment or deposit. This means the amount you owe on your car may be greater than its actual market value initially.
If your car is totaled, stolen, or severely damaged during this period, your insurer will compensate you for the vehicle’s current value only, forcing you to absorb the financial loss. Gap insurance helps cover the difference between your loan balance and what the standard insurance policy pays.
Gap Insurance Example
To give an example of how gap insurance works, assume your car has a current market value of $10,000, but you still owe $13,000 on your car loan. If you’re involved in an accident, and your car is considered a write-off, your standard insurance will pay a maximum of $10,000, leaving you $3,000 short on your loan repayments. Your car is also regarded as unroadworthy, so you don’t have a vehicle.
If you have additional gap insurance, your policy covers the gap between the compensation you received and the total owed on your car repayments. In this circumstance, gap insurance covers you against the $3,000 financial shortfall if your vehicle is considered a total loss.
When You Might Need to Purchase Gap Insurance
In most cases, gap insurance isn’t mandatory. If the market value of your vehicle is equal to or greater than the amount you owe on your auto loan, buying gap insurance might not be an economical choice. Gap insurance may only be necessary if you’re underwater on your car repayments. This means your vehicle is worth less than what you owe on payments.
Is Gap Insurance Worth It?
Some vehicles, such as luxury SUVs and certain sports cars, depreciate much quicker than regular vehicles. If you’re financing a vehicle that typically depreciates quickly, your lender may require that you purchase additional gap insurance coverage. Here are some other circumstances where gap insurance is worthwhile.
Car financing required a minimal down payment
While a small down payment saves you money in the short term, it can cause you to be underwater on your car loan initially. If your car is worth less than the amount owed on your loan for several months or a year, consider buying a gap insurance policy.
Your auto purchase has a poor resale value
If you buy a car with a low resale value, you’re likely to owe more on the loan than your car is worth unless you put a significant sum toward your down payment. Pay attention to the market value of your vehicle and consider a gap insurance policy to avoid losing out in the event of an accident.
Your auto loan term is five years or longer
The main advantage of a long-term car loan is the low-cost monthly repayments. However, this also means it takes longer for the loan balance and the car’s value to become equal. Protect yourself from financial loss by purchasing a gap insurance policy until your loan balance dips below the market value of your car.
You put up a lot of mileage
While all vehicles depreciate naturally, racking up miles accelerates depreciation significantly. Consider purchasing gap insurance if you’re worried that frequent driving will reduce your car’s value faster than you can make payments.
You trade in a vehicle with outstanding loan repayments
If you trade in a vehicle with outstanding payments, the existing loan balance is added to the new loan or lease agreement unless you pay off the remaining debt beforehand.
In an accident, this extra amount may cause increased financial loss. If you trade in a car that you haven’t paid off, ensure the gap between your new loan balance and the value of your new vehicle isn’t excessive. Alternatively, contact your insurance company for a gap insurance quote.
How to Purchase Gap Insurance
Car owners can purchase gap insurance from insurance providers, the lender who is financing your car, and sometimes through car dealerships during the end stages of your sale. While it may be more convenient to buy this insurance through the dealership selling the car, take some time to shop around for different rates, just as you would when purchasing home or life insurance.
Doing your research ensures you’re getting the best deal. Even if you’re buying a used vehicle, you may be able to purchase gap insurance through the dealership or an insurance provider to protect yourself financially if it depreciates. This is especially important when buying used vehicles that are trendy or are luxury sports cars.
Save On Your Annual Auto Expenses With Finance is us
Auto insurance is a necessity to protect you and your family if your vehicle is stolen or damaged. However, securing a good deal can be difficult with so many policies and insurance options to choose from.
At Finance is us, we can help you make educated decisions regarding insurance policies by breaking down different options, from gap insurance to home and health policies. Browse our site for more information on insurance, banking, investing, loans, and mortgages.
Disclaimer: All content on this site is information of a general nature and does not address the circumstances of any particular entity or individual, nor is the information a substitute for professional financial advice and services.
