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What is gap insurance in your car insurance policy?

  • Auto Insurance
  • Nick Jonathan
  • 6 minutes

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Gap insurance is an optional coverage in your car insurance policy. It assists in paying your auto loan if your car is totaled or stolen and you owe more than its depreciated value.

After a fair bit of research, our team of analysts found a startling fact. Most people do not consider gap insurance when purchasing car insurance. This could be because it is not required by law, and it is only useful in a few cases. However, if your automobile is totaled, gap insurance can prevent your bank account from being depleted. Let’s take a look at what gap insurance is and when it comes into play.

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Gap Insurance and Car Financing

We must first discuss how auto financing and insurance work before we can understand gap insurance. These are the two causes that make gap insurance necessary. A great majority of new car buyers use some form of financing to purchase a new vehicle. A lease, dealership financing, or a loan from your bank or credit union are some ways in which you can finance your new car. In all of these circumstances, you’re taking out a loan to drive the car off the lot today. You will, obviously, be repaying it afterward.

A lease normally lasts two or three years. After this, you must return the car to the dealership (or purchase it outright). Longer loan durations are common, with five or six years being the most common.

What you need to know

It’s crucial to understand that regardless of how you finance your new car, you’ll be “underwater” on the loan for a while. We’ve all heard that as soon as you drive a new automobile off the lot, it loses some of its value. However, keep in mind that your loan or lease does not change. You still owe the agreed-upon amount in full. Longer loans give you more time to fall behind on your payments. I.e, the increasingly popular 60- and 72-month loans. A modest down payment, or none at all, results in a greater loan amount. This can lengthen the period you’re underwater.

It’s also vital to understand that you don’t own the vehicle until the loan is paid off. It is owned by the bank or financing arm. If the vehicle is stolen or declared a total loss, the insurance company will pay the lender or the company that holds your lease. According to the insurance provider, the gap comes about when you are liable for the difference if you owe more than the car’s worth.

What is the purpose of gap insurance?

If you’re leasing or financing a new car, many lenders need collision and comprehensive coverage on your vehicle insurance policy until your automobile is paid off.

Gap insurance is intended to be used in conjunction with collision and comprehensive insurance. Your collision or comprehensive coverage will help pay for your totaled or stolen vehicle up to its depreciated worth if you have a covered claim.

When you drive a brand-new vehicle off the lot, its value drops immediately. In addition, the value of most automobiles depreciates by roughly 20% in the first year of ownership.

But what if your loan or lease balance is still higher than the vehicle’s depreciated value? That’s where gap insurance can come in handy.

Do I really require gap insurance?

Except for New Hampshire, every state requires some form of basic insurance coverage. Liability insurance is required in most states to cover property damage and medical expenses resulting from an accident you caused. Many states, especially those that are “no-fault,” also mandate personal injury protection (PIP) coverage. In circumstances when the collision is caused by a driver who does not have enough – or any – insurance, you may also be required to carry uninsured/underinsured motorist coverage.

However, it is possible that an insurance agent told you that gap insurance is essential. This is true only when lenders mandate it as a condition of financing or leasing a vehicle. If your new car is totaled six months after you bought or leased it, the lender doesn’t want to be responsible for the difference between the insurance payout and the loan or lease balance.

Yes, you’re technically responsible for the difference. But lenders do understand that most people don’t have a few thousand dollars stashed away in the event of an accident or theft. Gap insurance comes in handy in this situation.

How does gap insurance work?

Assume you paid $35,000 for a brand-new automobile. If your car is totaled in a covered collision, and you still owe $30,000 on your auto loan. Your collision coverage would reimburse your lender up to the depreciated value of the damaged car, say $25,000. If you don’t have gap insurance, you’ll have to spend $5,000 out of pocket to pay off your damaged car’s auto loan. If you have gap insurance, your car insurance provider will assist you in paying the $5,000.

In the example above, the car insurance refund goes entirely to your auto lender to pay off a non-drivable vehicle. Do you believe you may need assistance in obtaining a new car after your current one is totaled? If yes, you should consider purchasing new car replacement coverage.

Some insurers bundle loan/lease gap coverage and new car replacement coverage into a single add-on to a brand-new car insurance policy.

Is gap insurance worth the cost?

If you’re considering buying gap insurance, it’s important to remember that this type of coverage may only be available. Especially, if you’re leasing or financing a new vehicle. If so, consider how much you owe on your automobile loan compared to its worth.

Websites like Kelley Blue Book can give you an estimate of how much your car is worth. Do you owe more on your vehicle than it is worth? If your car is totaled, could you afford to pay the difference out of pocket? According to the Insurance Information Institution, you may want to buy gap insurance if you’ve only made less than a 20 percent down payment on your vehicle or if your car loan is 60 months or longer.

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