How It Works
Usually, the value of a new vehicle starts depreciating the moment you have the title registered in your name.
According to experts, a new car can lose as much as 20% of its value in the first year alone.
When you finance a car by putting in a lower down payment, you might face a situation in the first couple of years where the amount of the outstanding loan will be higher than the vehicle’s value.
In case of an accident during these first couple of years of ownership, this gap insurance will cover the difference.
It is quite versatile and provides comprehensive coverage. Yet, keep in mind that it only covers the vehicle’s damage as a result of an accident.
For instance, imagine you owe $15,000 on the current loan and your car is damaged. At the time of the accident, the car’s ACV was $10,000.
Note that the ACV is often referred to as the upside-down value of your loan. If you opt for gap insurance, the remaining $5,000 can be covered by the policy.
If not, this amount has to come out of your savings.
While collision and comprehensive coverage is required, gap Insurance isn’t mandatory.
If your lender says you must get one, the Consumer Financial Protection Bureau suggests checking if the same requirement is listed in the sales contract.
If not, adding this policy can be done totally at your own discretion.
When It’s A Good Idea
If you intend to buy gap insurance, you must note that it is possible to have this form of coverage only if you lease or finance a new car.
You should run an estimate of your vehicle’s depreciation value and the outstanding balance to confirm if you can afford the balance out of your pocket.
It is also a smart idea to compare the actual cost of the insurance plus the taxes and any other expenses to the MSRP or purchase price of the vehicle and see if there is a difference from the beginning itself.
According to the Insurance Information Institute (III), you might consider a gap insurance policy if:
- You paid less than 20% down payment when financing the car
- The repayment term of your auto loan is 5 years or more
- You’re leasing a car
- You bought a vehicle that has a higher depreciation rate than the average market rate
- You’ve rolled over a negative equity from a previously outstanding loan into a new loan
You must still be mindful that your "gap insurance" will fluctuate.
Ideally, as you make monthly payments and the vehicle depreciates over time, the gap between what is owed, and the car’s actual value will shrink.
When It’s Not Recommended
You might not want to buy gap insurance if:
- You have made a large down payment
- You purchased the vehicle in cash
- The repayment term is 36 months or less
How Do You Get Gap Insurance?
There are three ways to get gap Insurance:
(a) through the dealer
(b) a car insurer
(c) a standalone gap insurance provider/underwriter
Dealership insurance plans are generally on the more expensive end of the spectrum, so compare options before deciding on a policy.
Make sure you know the terms of your loan and the value of the car when looking for the best price.
A good idea is to compare multiple quotes before choosing one.
State Farm, Allstate, Progressive, USAA are some renowned service providers that you can explore for competitive rates and flexible terms.
Conclusion
This form of optional insurance coverage is designed to work in conjunction with your vehicle’s comprehensive and collision insurance policies.
Yet, it isn’t necessarily a beneficial add-on for every car owner.
Before signing on the dotted line, we recommend calculating the current value of your vehicle and the outstanding debt on websites like Kelly Blue Book to verify if you really need this extra policy.
