There are two ways you can lose your car – when it is totaled or stolen. Either of these two events can leave you with huge losses. You can mitigate the losses by purchasing insurance.
Two of the essential car insurance policies are collision and comprehensive coverage. It covers the cost of replacing a car when it is totaled. There’s also car replacement coverage for a car that’s stolen.
While these insurance policies are essential in paying for the car’s value when an incident occurs, the responsibility of paying off the car loan is squarely upon you. It doesn’t matter whether the payout from the claim is not enough to pay your loan entirely.
At that point, you need another car insurance policy called gap insurance. The purpose of this article is to provide a comprehensive discussion of gap insurance and how it works. Keep reading for more information.
What Is Gap Insurance
Gap insurance is optional car insurance, which pays off a car auto loan when a vehicle gets stolen or totaled. It fills in the gap between the totaled car’s depreciated value and the loan balance when it is more.
It is also called loan or lease gap coverage. It is only available to original car leaseholders or loan-holders of new vehicles. Gap insurance is effective in helping you offset what you still owe on the vehicle after it gets totaled.
It is beneficial and protects you in certain circumstances, relieving you of unmitigated costs. Since it is an extra cost when purchasing a vehicle, you may want to reconsider it. However, gap insurance could be a requirement by the car dealership, making it impossible to opt-out. So, is gap insurance worth it?
When Do You Need to Purchase Gap Insurance
You need to buy gap insurance if you’re financing or leasing a new car. As part of your auto insurance, the lender may require you to have collision and comprehensive coverage until you fully pay off the car.
Gap insurance works together with comprehensive and collision coverage. If you have a claim on a totaled or stolen car within the term of the lease or financing, comprehensive and collision coverage pays for it. However, it only covers the vehicle’s depreciated value.
The Insurance Information Institute (III) observed that a brand-new car’s value decreases immediately you drive it off the lot. The value goes down by at least 20 percent one year after purchase for most new vehicles.
Therefore, the car owner will likely have a higher loan balance than the car’s depreciated value. That means that the car is worth less than what you owe on it. Gap insurance covers the difference in the car’s value and what you still owe on the car loan.
When a car is totaled, its value is much less than the cost of repairing and restoring it. The decision to get a car totaled depends on the law of the state and the insurance company’s discretion.
How Does Gap Insurance Work
Suppose your car gets stolen at a time when its value is $35,000, and the car owner still has a $40,000 car loan. Comprehensive insurance will pay $35,000, which is the car’s value.
However, there’s a $1,000 deductible. The insurance company gives you $34,000, and you still need to pay $6,000.
The purpose of gap insurance is to pay the $6,000 to ensure you do not owe money on the stolen car. Without gap insurance, you must cover the loan balance and the value of the replacement vehicle.
Is Gap Insurance Worth It
You may not necessarily need gap insurance. The following are the instances when you may not need gap insurance:
- You paid for your car in cash (you neither lease nor take a loan)
- You’ve made a substantial down payment so that the loan balance is below the car’s value
If you have a car lease or have taken a new loan, you must consider paying the difference between the loan balance and the value of the car. Besides having a comprehensive auto insurance policy, you also need to get gap insurance.
The III advises that you consider taking gap insurance if the following is valid:
It’s a Requirement
The car dealership or financier may require you to get gap insurance. That’s because the car dealer wants you to get protected when your vehicle gets totaled. However, you don’t have to take gap insurance from the car dealer. Since it isn’t part of your lease or loan, you can approach another auto insurance company for a better deal.
If you make a small down payment of less than 20 percent on the vehicle, it will likely lose its value faster, leaving you with negative equity. If the car gets totaled, you will need gap insurance to cover the difference between the loan and the car’s actual cash value.
A Long Auto Loan Term
If the time remaining on your car loan is 60 months or more, it is necessary to gap insurance. With such an extended loan term, the car will likely have a negative actual cash value on the car.
Luxury vehicles tend to depreciate faster than their low-end counterparts. Therefore, if you have a high-end vehicle, your loan amount will likely shoot above the car’s value sooner than later.
The value of a car often depends on how far the owner drives it. If you drive your car over long distances, it’s likely to lose its value faster. The more the mileage, the less the value of the vehicle.
Gap Insurance Providers
Gap insurance provides financial protection if a car gets totaled. It is usually essential to buy gap insurance in the first three years of leasing or buying a new car. The insurance company may require the following:
- Proof that your car is at most three years old
- Evidence that you’re the vehicle’s original owner
Remember, buying gap insurance from an auto insurer is better than getting one from a car dealer. The latter’s deal includes an interest payment, increasing monthly payments on the car. It might take you time to find a suitable insurance company, but it’s worth the while.
The following are three main ways to buy gap insurance:
Your Auto Insurer
You likely have a reliable insurance company to secure comprehensive and collision coverage. All you need is to include the new car replacement coverage in your regular insurance.
A Gap-Insurance Only Company
You Could find a standalone insurance carrier to provide you with gap insurance. Insurance companies in this category operate online and require a one-time premium payment.
Lender or Dealership
Lenders or dealerships offer their customer’s gap insurance, with the cost included in the loan payments. That means you have to pay interest on the cost of gap insurance for as long as the loan lasts.
How Much Does Gap Insurance Cost
According to the III, auto insurers may charge only a few dollars monthly or nearly $20 monthly. The actual cost will depend on the value of the car. Don’t forget to buy comprehensive insurance. To pick the best, you may want to compare car insurance rates among two or three insurance companies.
On average, lenders may charge a flat fee for gap insurance between $500 and $700. The actual cost depends on the lender you pick. Some lenders, such as credit unions, may have much lower charges.
In the case of lenders, the cost of gap coverage adds to your loan. Therefore, you have to pay interest on the cost of insurance. According to Edmunds, the average interest on the cost of a loan and gap insurance can be nearly 6%. In three years, you could end up paying more than $800 compared to auto insurers, whose three-year insurance cost can be $60.
Due to variations in insurance rates, you should take time to compare several insurance companies before picking one that’s less costly.
Gap Insurance Alternatives
While gap insurance covers the difference between the value of a vehicle and the loan amount, it isn’t the only way to protect yourself. The following are some of the options you could consider:
You can make a loan or lease payoff whether you have a new or used car. The payoff caters to a portion of the vehicle’s value, usually 25%. It is, therefore, cheaper than gap insurance.
New Car Replacement Coverage
As a car owner, you could be worried more about whether you can buy a new car than pay off the old one. In that case, you need new car replacement coverage. Even though it’s more expensive, it is one of the best auto insurance policies for getting your vehicle replaced with a new car. You’ll get the same car make and model, minus the deductible.
Better Car Replacement Coverage
You can only secure a gap insurance policy or new car replacement coverage if you have a new car. In that case, the only offer from the insurance company could be better car replacement coverage. That can cover the balance on your auto loan if the car gets stolen or totaled.
The Bottom Line
You need gap insurance if you have just financed or leased a new car. However, it is an optional coverage in addition to comprehensive insurance and collision insurance. If your car is totaled or stolen, gap insurance plugs the gap between the value of your vehicle and the auto loan amount. Does gap insurance work? It works for those with a longer-term auto loan, low down payment, and bought or leased a new car.
Frequently Asked Questions (FAQ)
What is Gap Insurance and How Does it Work
It can take as little as five business days for an insurance company to make a gap insurance payout. The most important factor is your location. In some places, the payout process can last for several weeks before completion. Since it takes 30 days to total a vehicle, you can wait after that to start counting the payout period.
When would gap insurance not pay?
Gap insurance may fail to honor a claim due to various reasons. For example, gap insurance won’t pay if your car is repairable. After the accident, it also won’t pay for a replacement vehicle, injury, and medical costs, a failed engine, or car rental.