When you get into a car accident while you have an auto loan, you can end up paying dearly for a vehicle you no longer use.
Gap insurance aims to protect drivers from this scenario by acting as a financial bridge between the amount owed on the loan and the car's estimated fair market value.
What Is Gap Insurance?
Gap insurance, or “GAP insurance," stands for “Guaranteed Auto Protection". This insurance protects you from paying out what can be a significant difference between:
- The amount you owe on your car loan.
- The car's current estimated value.
It is common for a driver to assume that in the event his car is stolen or totaled, his collision and comprehensive insurance will cover all the costs.
However, comprehensive and collision insurance only covers the car's current fair market value (actual cash value).
When you get into an accident, you might find the fair market value of your vehicle is a lot lower than you thought. This is because vehicles depreciate at an especially rapid rate.
The Effect of Vehicle Depreciation
When you consider how quickly a vehicle depreciates, the importance of gap insurance becomes clear. Edmunds estimates that a vehicle depreciates by:
- 10% as you drive it off the lot.
- 40% EVERY year.
On average, a vehicle is only worth 37% of the purchase price at the end of 5 years.
Gap insurance can save you from paying thousands out of pocket due to depreciation.
Example: How Does Gap Insurance Work?
Let's say you buy a new car.
- The purchase price is $30,000.
- You make a $2,000 down payment and take out a $28,000 loan.
- You set up monthly payments of $500.
Two months later, you get into an accident and your car is totaled. What happens?
- You currently owe $27,000 on your car loan.
- Your insurer estimates the car's fair market value at $21,000 and pays you as such through your collision coverage benefits.
- You are left with a $6,000 difference between the amount you owe your lien holder and the amount your insurance carrier pays.
Gap insurance eliminates this deficit, saving you from this potential financial hole.
Who Needs Gap Insurance?
Whether you need―or are required to have―this guaranteed auto protection (GAP) depends on a few factors.
Gap insurance is often required as part of a lease contract, and is commonly included in the lease agreement for a fee. Otherwise, you probably won't be forced to obtain the coverage.
When you take out a loan for a car, keep in mind that because you will be receiving a larger loan, the smaller your down payment, the more important gap insurance becomes. Having gap insurance may be a particularly sound move if you buy a new and/or expensive car.
Understand that there are limits on how much a gap policy will pay. Your insurance provider should go over those details with you. If they don't, make sure to ask.
NOTE: In many cases, you can only use gap insurance if you hold comprehensive and collision coverage. Other conditions may also apply.
Where to Get Gap Insurance
Your auto insurance policy may already contain gap insurance. If not, you can purchase it through most large carriers, or obtain it from companies that specialize in this insurance.
Again, gap insurance often is included in lease contracts. But be sure to see what's covered and how much you'll pay for the protection.
What About Loan/Lease Coverage?
Loan/lease payments coverage is very close to gap coverage; it has only one major difference:
It only pays up to a certain percentage of your vehicle's actual cash value.
For example, if your insurance provider sets its cap at 25% for loan/lease payments coverage, it will pay the difference between your loan amount and the car's estimated current value but only until it reaches 25% of the current value.
Applying this to our previous example, your loan/lease coverage will provide you with $5,250 to apply to the $6,000 difference between what you owe on your loan and what your collision coverage pays out.
In some cases loan/lease coverage will cover more than enough to pay off the rest of your loan, but often you will find a difference between what your insurance will pay you and what you own on your loan. You will be responsible for paying the difference.
Whether you purchase gap insurance or loan/lease coverage, remember to ask about the details of the policy and any requirements that may apply.