What Is Gap Insurance and Is Gap Coverage Worth It?
A serious accident or the theft of your car is very bad news. But it can be worse when your auto insurance plan doesn’t cover what you owe on the car.
If you owe more than your car is worth, then you are “upside down” in your auto loan. In the event of a catastrophic loss, a standard car insurance policy will cover up to the replacement cost of your vehicle, but they don’t cover any “negative equity” you owe your lender beyond that.
Gap insurance is a secondary form of insurance designed to cover that gap. There are many options for purchasing gap coverage, and a smart consumer can save hundreds of dollars by heeding our tips below and shopping wisely.
What Is Gap Insurance And What Does It Cover?
Gap insurance covers, in case of accident or theft, the dollar-amount “gap” between what a car is worth and what is owed on the loan. “Gap” stands for “guaranteed auto protection” or “guaranteed asset protection.”
The moment you drive a new car off the lot, it loses about 10 percent of its value -- and loses about 20 percent within the first year according to Edmunds.
Let’s say you buy a new Honda Accord for $27,000. The day is purchased, its “actual cash value” (ACV) falls to approximately $24,300. One year later the actual cash value might be approximately $21,600.
If a buyer or lessee were to suffer a total loss without gap insurance, standard insurance would only cover the actual cash value of the car, leaving the driver potentially owing thousands of dollars to the bank. And no car.
How does gap insurance work with our new Accord driver?
|New Honda Accord||$27,000|
|Balance after one year (4 percent interest/five-year loan)||$23,868|
|Actual cash value after one year||$21,600|
|Insurance payment without gap coverage||$21,100|
Gap coverage would pay all of the nearly $3,000 deficit including the $500 deductible.
In summary, gap coverage works alongside liability, collision and comprehensive insurance to protect car owners with negative equity. It can also pay deductibles, within a limit. Check to make sure your collision and comprehensive deductibles aren’t greater than what your gap policy will cover.
Who Needs Gap Insurance?
Auto loans that spread out payments over five, six or seven years can make it easier for consumers to afford a car purchase, and long-term loans are more common than ever. According to Experian Automotive, the average car loan today has a 66- month term, and nearly one-quarter of all car loans are for terms longer than 6 years.
But the more time it takes to pay off a loan, the longer it takes for loan payments to catch up with the car’s depreciating value. So long-term loans almost guarantee that the car buyer will have negative equity for some period of time.
There are many other ways consumers can find themselves upside down on auto financing. If any of these applies to you, you should look into gap coverage:
- Zero or low down payment loans. Making a down payment helps close the gap between what you owe and the car’s depreciated value.
- Leasing your car. Auto leases have lower monthly payments than loans because the buyer pays much less principal every month. Many include gap coverage automatically.
- Makes and models that depreciate faster. Some cars depreciate much faster than others. Sources like Edmunds and Kelley Blue Book can help you compare the expected depreciation of different makes and models.
- Rolling other products into your auto financing. Financing extended service agreements, dealer-installed options or debt from previous auto financing increases what you owe without necessarily increasing the value of your car.
- High mileage. Driving more than 15,000 miles a year speeds up your car’s depreciation.
How Can I Get Gap Coverage, And How Much Does It Cost?
Leases commonly include gap coverage or waiver of “gap liability.” So if you have leased a car, chances are you’re already covered. Read your lease terms carefully to avoid purchasing additional gap coverage you don’t need.
If you get a car loan you have several options for gap coverage.
Gap insurance is available from many car dealers, but these policies are usually quite expensive: $600 or more isn’t uncommon. This is charged up front as a lump sum, and it can be included in the financing for the car’s purchase. Like most things sold by car dealers, the price is generally negotiable.
Gap coverage may also be available from your lender, and its cost will be included in the total amount you finance with the loan.
But the best deal is generally available from your auto insurance company. Many offer gap coverage, and instead of being due up front, the costs are included in regular premium payments. It can amount to as little as $5 per month for the period you are upside down on the loan.
You can also shop for a “loan/lease coverage” policy that works like gap insurance, but limits the payout to a certain percentage of the car’s total value.
If you sell your car before paying off the loan and you paid for gap insurance up front, you are often entitled to a refund for the portion of the insurance you didn’t use.
In Summary: Is Gap Insurance Worth It?
If you purchase a new car with zero or low down payment financing, or if your car loan extends for five or more years, you definitely should understand your exposure and weigh the cost of gap coverage.
Don’t assume you have to buy gap insurance from the dealer; be sure to check into the options available from your lender and your auto insurance company. If you bought coverage from the dealer, it might not be too late to shop elsewhere. It is likely you can cancel it and get cheaper coverage elsewhere. You can then go back to the dealer for a refund of any prepaid coverage you didn’t use.
If you shop around, you are likely to find gap insurance is an affordable way to protect you from the risk of a big expense in the event your car is totaled or stolen.
If you don’t purchase this coverage and find yourself facing a remaining loan balance after an accident, all is not lost. Through a “collateral exchange,” you may be able to roll the balance of your old loan into a new auto loan or lease when you buy a replacement car.
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