Gap insurance is a valuable type of auto insurance that you can obtain to protect yourself in scenarios where your car is totaled, and the compensation received is insufficient to cover the remaining balance on your financing or lease agreement. If the balance of your car loan exceeds your vehicle’s book value, gap insurance can cover that difference.
Key Points to Remember
- Covers Loan Difference: Gap insurance bridges the gap between your vehicle’s value and the outstanding amount on your loan or lease.
- Who Needs It: Particularly useful if you owe more than the car’s value due to no down payment or a long loan term.
- Variable Costs: The cost varies by state, driving record, and vehicle type.
- Purchase Options: Available as an endorsement on your existing auto insurance policy or as separate coverage from the dealer. Always compare both options for cost efficiency.
How Gap Insurance Operates
Vehicles quickly depreciate in value, often making it common to owe more on a car loan than what the car is worth. In fact, the average car depreciates by 10% within the first month of ownership.
Should your car be totaled, your insurance will reimburse based on the depreciated value of the car—not the price you initially paid, new replacement costs, or the remaining loan balance. This is where gap insurance proves crucial.
Example: If you bought a car two years ago and still owe $20,000, but its current value has dropped to $15,000 due to depreciation, and it’s then totaled, your insurance will pay out only $15,000. Without gap insurance, you’d be $5,000 short to clear your loan, despite not having the car any longer. Gap insurance would cover that missing $5,000, ensuring you’re not left in financial disarray.
When To Consider Gap Insurance
- Minimal or No Down Payment: Financing a car without a significant down payment can leave you upside down the moment you drive off the lot and keep you there for years.
- Trading in an Upside-Down Vehicle: If you still owe money on your trade-in, the balance gets added to your new car loan, potentially leaving you vulnerable if the new car is lost or stolen.
- High Mileage planning: Rapidly adding miles decreases car value swiftly. You’re likely depreciating faster than making payments.
- Long-Term Loans: Loans that extend beyond 60 months take longer to reach equity with the car’s value and leave more room for financial risk.
Should You Get Gap Insurance?
Consider gap insurance if you’ve made a minimal down payment, plan to drive a lot, or have taken an extended loan term. It’s essential for shielding yourself against rapid depreciation. Ensuring you’re not suddenly upside down on your loan is practical, especially for long road trips or rough terrains.
Is It Mandatory?
While gap insurance isn’t typically mandated, it might be stipulated in your financing terms. It’s important to thoroughly review your loan or lease agreements. Leasing may often require you to have gap insurance.
Cost Factors
Gap insurance costs vary by state, driving record, age, and vehicle specifics. Some insurers provide it as an endorsement to your current policy, whereas dealerships offer it separately—often at a higher price. Always compare costs across sources.
Bottom Line
Gap insurance serves as a critical safety net, covering the difference between a car’s actual cash value and the remaining loan or lease balance. It protects you from financial gaps in the regrettable event of a total loss, providing peace of mind even as values diminish.
Related Terms: auto insurance, car financing, lease breaking, vehicle depreciation, car loan.
References
- Progressive. “What Is Gap Insurance?”
- Carfax. “Car Depreciation: How Much Value Does a Car Lose Per Year?”
- Insurance Information Institute. “What Is Gap Insurance?”
- Nationwide. “Gap Insurance”.
