Gap Auto Insurance Coverage
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UPDATED: Jan 19, 2022
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Auto insurance is all about protecting yourself and your assets in the event of a car accident, theft, or catastrophe. Whether your new vehicle is wrecked by an accident, stolen from your parking space without a trace, or totaled by a storm, gap insurance will at least make sure that you are not still stuck with the car payments.
There are some instances where you definitely need gap auto insurance to protect yourself financially.
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GAP stands for Guaranteed Auto Protection insurance, and it is just an optional insurance coverage in most instances–you do not have to have it by law.
While it is not a necessity by any state laws or regulations, your car loan lender might require that you carry gap insurance as well as other optional insurance.
Gap Insurance Defined
When you buy a new vehicle, you may pay much more than the Manufacturer’s Suggested Retail Price (MSRP) or even the vehicle’s true market value. Your vehicle may have additional options, upgrades, or future maintenance services such as oil changes that increase your loan amount.
Add on taxes and registration fees, and your loan increases hundreds of dollars over the sticker price of the vehicle.
Then, most vehicles lose a significant amount of value once they are driven off the dealer’s lot, whether or not you pay more or less than the MSRP. During your first few years of owning a new vehicle, you will likely owe more on the loan than the vehicle is worth.
Put in simple terms, you would not be able to sell it for what you owe on the loan.
If you get into an accident or suffer a catastrophe that makes the vehicle a complete loss, you are still responsible for repaying the full amount of the vehicle loan. Your lender will still want to be repaid.
Your auto insurance will cover the market value of your vehicle, not the full amount owed, according to the National Association of Insurance Commissioners (NAIC). That difference, or gap, must be repaid out of pocket by you.
When You Should Have Gap Insurance
Gap insurance is a necessary safety net any time that you owe more than your vehicle is worth. According to Bankrate.com, most vehicles lose 30% of their value in the first year of ownership and 50% of their value after three years.
Conventional wisdom maintains that the value of your new vehicle decline hundreds or even thousands of dollars as soon as you drive away from the car lot. If your loan payments are not keeping pace with the depreciation of your vehicle, then you will likely owe more than the market value of your vehicle.
If you suffer a total loss of your automobile through an accident or catastrophe, then you will be on the hook for the difference between the market value and the remainder of your loan.
For instance, a $30,000 vehicle would be worth roughly $21,000 after depreciation in the first year–that is how much your car insurance will kick in if the vehicle is totaled.
However, you likely still owe more than $25,000 on the vehicle after only a year of payments, so you will have to pay the $5,000+ to cover your loan out of your own pocket if you don’t have gap insurance.
Scenarios Where You Should Have Gap Insurance
Bankrate.com listed the instances when you are likely to owe more on a vehicle than it is worth. Gap coverage is a must-have in the following instances to protect your financial interests:
You have leased a vehicle. Drivers have very little equity in leased vehicles, so gap insurance is a must to cover the costs in the event of a total loss.
You car loan was financed with less than 20% down. A large down payment will help to close the gap between the loan amount and the market value after a year. A small down payment will leave that gap wide open, as you have not built up equity in the vehicle.
You have stretched your payments over a longer time frame than five years. If you finance for a longer period of time, then it takes longer to build up equity in the vehicle. Essentially, it is taking longer to pay off the gap between the loan amount and the market value.
You refinanced your old car loan as part of your new loan. When you trade in a vehicle that has not been fully paid off, then the balance of your old loan gets added to the balance of your new loan.
Called negative equity, your old loan balance increases the gap between market value and the loan amount.
You drive more than 15,000 miles a year. High mileage drives the market value of a vehicle down, causing your vehicle to depreciate at a faster rate. So if you use your vehicle for cross-country vacations or you have a long commute every day, you should consider gap insurance.
You buy a vehicle that historically has a low resale value. Vehicles with a low resale value depreciate faster than other vehicles in their class for a myriad of reasons. The automobile market value expert, the Kelley Blue Book, has set the standard for projecting the value of past and present automobiles.
Research a vehicle before buying to ensure that it is not going to lose its value too quickly.
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When Gap Insurance Is Unnecessary
While gap auto insurance is good idea when your vehicle is new or just a few years old, it is pointless coverage to have if your vehicle is worth near what you owe.
Keep track of your loan balance with every payment or call your lender to tally your actual balance so you are always aware of your loan’s current balance.
Keep in mind that the remaining balance of your loan is not what your car is worth; it is how much you still owe on the loan.
Then, find the market value of your vehicle for the mileage of your car, the condition of your vehicle, and any other issues, such as scratches and dents, which might lower the resale price of your vehicle.
It would probably also be a good idea to call your insurance company to find out how they determine the market price of your vehicle so you can determine the value of your vehicle in the same way.
If the amount you owe on your auto loan is less than that of your car’s market price, then you don’t need gap insurance. If you get into an accident, your vehicle is stolen, or it is a complete loss due to a covered incident such as a falling tree, then your regular auto insurance coverage should be enough to cover your remaining loan.
Your money will be better spent elsewhere rather than in buying gap insurance.
How to Avoid Needing Gap Insurance
There are a few ways to ensure that you won’t have to pay for gap insurance at all. They all require substantial financial planning and consideration to ensure that you truly do not need the coverage. You won’t need gap insurance if:
Your leasing company picks up the gap insurance coverage to protect its own financial interests.
You get a great deal at the dealership. Knowing the fair market value of a vehicle is crucial before beginning the buying process. Getting a good interest rate on your auto loan will help as well, as a low interest rate can lessen your total loan amount dramatically.
You make a substantial down payment. As your new vehicle will likely lose 30% of its value in the first year, aiming for a down payment at or above 30% will make sure that you have equity in your vehicle to match depreciation.
You buy your vehicle outright. If you have the cash to cover the cost, then gap insurance is unnecessary. You can also cancel gap insurance once you own your vehicle or your loan debt and market value meet–whichever comes first.
Buying Gap Insurance
Gap insurance can be purchased in many different places. Generally, the least expensive option is to purchase gap auto insurance coverage from any company that sells auto insurance.
However, your lender may require you use a particular company for gap insurance, and you might not have a choice regarding where you buy the coverage.
Also, gap insurance is usually the most expensive through the dealership, so shop around before buying any coverage that seems too expensive.
Make sure that you understand all of the conditions of your gap insurance and other coverage. For instance, gap insurance companies generally require that you also maintain collision and comprehensive coverage because gap insurance will not pay for all of your damages, only the difference between what your regular insurance will pay and what you owe to your lender.
Furthermore, some gap insurance won’t pay for negative equity that is rolled over from an old car loan. Make sure to read the fine print.
Edmunds.com explains how gap insurance affects your car loan or lease. Once you read this article, you can see how you’d be financially out of luck if you had a total loss on your vehicle before it had been completely paid for.
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