Financing a Vehicle: Do I Need Gap Insurance?

When you buy or lease a new vehicle, it starts to depreciate the moment it leaves the lot. Beyond that, most cars lose 20% of their value within a year. If you financed your vehicle, your lender will likely require that you purchase “full” or comprehensive and collision coverage to protect their investment. This protection will better cover you in the event your car is damaged, stolen, or totaled. However, most insurance companies will only cover the market value of the car, which considers the depreciation of its value over time.

Financing a Vehicle: Do I Need Gap Insurance?

Depending on your loan and the value of your car, there may be a disconnect between how much you owe on the car and its value. This is called negative equity. What does this mean for you? If you are in an accident with your new car and it is totaled, your car’s value may be less than what you owe on it and your insurer will only compensate you for what the car is worth. You will be responsible for the remaining amount owed on your loan or the “gap”.

What is gap insurance?

Fortunately, there’s gap insurance. Gap insurance is an optional coverage that can help protect you in the event your car is totaled while you still owe on your loan. Totaled means the costs to repair your vehicle exceeds the value of the vehicle. As an example, let’s say you purchased a brand new $20,000 car and after a period of time, you now owe $15,000 on your loan. Now let’s say you are in an accident and the insurer totaled your car and the market value is now only $14,000. Since your loan has $15,000 and the insurer is only paying $14,000, you would still owe $1,000 to your loan. Gap insurance would help pay that $1,000 difference (after your deductible).

According to the Insurance Information Institute (III), it may be a good idea to purchase gap insurance if you made less than a 20% down payment on your car, if you financed it for 60 months or longer, if you are leasing the vehicle (as it is usually a requirement in this case), if you purchased a vehicle that depreciates at a faster than average rate, or if you rolled over negative equity from an old car loan to a new one.

What gap insurance does not cover

To put it simply, gap insurance only covers you if your vehicle is totaled. It does not cover property damage or bodily injuries resulting from an accident. Gap insurance can cover you in the event your car is stolen and unrecovered, but it will not cover you if your car’s engine fails or there is a death as a result of an accident.

Where to get gap insurance

Usually, you can purchase gap insurance from the dealer you purchase your car from. However, you will usually pay more than if you purchased coverage from a car insurer. You can also purchase a type of gap coverage from your auto insurer, it it’s offered. Some, not all, car insurers may allow you to purchase gap insurance after you purchase your car, but many require your car to be brand new. Gap insurance is usually affordable and can give you peace of mind in the event your new car is totaled while you still owe on it.

When considering gap insurance, keep in mind that a gap between your car’s value and the amount you owe may linger for a couple of years. Gap insurance can prevent you from being solely responsible for the difference in the event of a total loss of your vehicle. This gap will eventually vanish but in the meantime, there’s gap insurance.


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