When a vehicle is deemed a total loss, whether damaged or stolen, gap insurance covers the difference between the amount of money you owe on the vehicle versus the actual cash value of the vehicle.
Let’s break it down: the adage is that once you drive a car off the lot, it’s already depreciating in value. In this Edmunds infographic, a new car could depreciate by as much as 37% within the first five years. According to the Insurance Information Institute, a car depreciates in value as much as 20% in the first year. Let’s say you take out a loan for $30,000 and finance the entire amount for 60 months. A year later, you get into an accident and the car is totaled.
Twenty percent depreciation in the first year equals $6,000, meaning the vehicle you purchased for $30,000 is valued at $24,000. The problem is, you may owe more than $24,000 to your lender. In this example, let’s assume after a year of making auto loan payments, much of it going to interest, you owe $25,500. This is referred to as being upside-down on a loan. Your car is worth $24,000 but you owe $25,500. In this scenario, if you purchased collision and/or comprehensive (your lender would most likely require it) your insurance would pay your lender $24,000 and you would be on the hook for the other $1,500.
Gap insurance addresses this issue. If you purchase gap insurance, you would be covered for the $1,500. That’s why gap insurance is important. However, it’s not for everyone.
Who Needs Gap Insurance?
The Insurance Information Institute recommends considering gap insurance for the following scenarios:
Made less than a twenty percent down payment.
Financed for 60 months or longer
Leased the vehicle.
Purchased a vehicle that depreciates faster than average.
Rolled over negative equity from an old car loan into a new loan.
Who Offers Gap Insurance?
Your car dealer may offer gap insurance at the inception of the loan. Car dealers typically charge between $400–$600 (it may be offered as a one-time fee or rolled into your loan payments). According to the Insurance Information Institute, with most auto insurers, gap insurance typically tacks on about $20 annually to your premium. However, not all auto insurers offer gap insurance. Some insurers, such as esurance, offers a variation called loan/lease coverage. Loan/lease coverage only provides some percentage of your car’s actual cash value–often up to 25 percent. In the above scenario, 25 percent of a vehicle valued at $24,000 is $6,000, which would be enough to cover the remaining $1,500 owed on the loan. However, esurance warns, “loan/lease coverage may not always be enough to cover you, so consider the breadth of your gap before purchasing loan/lease coverage.”
When buying or leasing a car and shopping for car insurance quotes, it’s worth your time to compare what types of gap insurance is offered (if any) and how much it will cost versus the auto dealer. Gap insurance is only necessary when what you owe outweighs the value of your vehicle. Check Kelly Blue Book or Edmunds to get an idea of the value of your vehicle, and when you determine that the value of your vehicle is greater than the amount you owe, you can remove gap insurance from your policy.