What is Gap Insurance? Why do you need it?

Introduction

The last thing you want to hear if your vehicle is stolen or damaged is that you owe more on the loan than the car is worth.

If you have collision or comprehensive insurance, your car insurance provider will pay the value of your vehicle as a complete loss payout rather than the balance of whatever loan or lease you may have on the vehicle. However, gap insurance might assist in closing the difference if you owe more on your car than it is worth.

Here is a look at what gap insurance is, and why you need it.

What is gap insurance?

Car owners can consider buying gap insurance, a type of auto insurance, to protect themselves from losses that might occur if the amount of compensation received, in the event of a total loss, is insufficient to cover the amount the insured owes to the finance or leasing arrangement for the vehicle. This occurs when the outstanding debt on a car loan exceeds the vehicle’s book value. 

How does gap insurance work?

The most your insurer will pay out on a claim for a totaled vehicle in an incident covered by collision or comprehensive insurance, is the car’s pre-accident value.

Gap insurance, also referred to as loan/lease coverage, compensates you for the difference between the amount you owe and the value of your totaled or stolen car.

A typical gap insurance claim proceeds as follows:

  1. You file a claim on either the collision or comprehensive insurance section of your policy if your car  is stolen or totaled in an accident 
  1. Your auto insurance provider reimburses you for your vehicle’s ​actual cash value (ACV), less any deductibles. For instance, your insurance payment would be $16,500 if your automobile is worth $17,000 and you have a $500 deductible.
  1. Or for example, if you owe $20,000 and the ACV is $17,000 your gap insurance will provide $3,000. Gap insurance will cover the difference if you owe more on your loan or lease than what is covered by your insurance.

You will be liable for paying off the loan yourself if you don’t have gap insurance and the remaining debt on your loan or lease is higher than the worth of your car.

You might need to get gap insurance, depending on your lender or leasing company. This is because, if the car is totaled or stolen, it helps shield companies from buyers who walk away from a loan or lease.

Some gap insurance policies may protect you for the entire loan balance, even if negative equity has been rolled into your new auto loan, for instance, if you trade in a car for which you owe more than it is worth. If you rolled negative equity into your new car loan, be sure the gap insurance policy you choose does so because not all policies do.

Why do you need gap insurance?

Depending on how much of a loan or lease you still owe and how much the car is worth, you may or may not need gap insurance.

The following are some typical scenarios in which gap insurance may be useful:

  • Your vehicle is leased
  • You obtained a car loan for at least five years (60 months)
  • ​​You only put down a payment of less than 20% on your car, with the majority of the cost being financed
  • You included the negative equity from your previous auto loan in your current one (make sure you get a policy that covers negative equity)
  • You purchased a car that loses value more quickly than other cars (more on that below)

If you presently have a car loan or lease, you may use a website like NADAguides to compare the worth of your car to the remaining sum of your loan or lease. The distance separates the two, which is the gap.

There is no need to carry gap insurance, however, once the balance is just marginally (if at all) greater than the worth of your car. This is because there will be little to no chance of receiving a gap insurance claim. If your car is totaled or stolen but you owe $15,000 and your ACV is $17,000, for instance, there won’t be a gap.

Additionally, you should consider canceling your gap insurance if you sell your car.

What doesn’t gap insurance cover? 

The following are some typical costs that gap insurance doesn’t cover:

  • Your vehicle insurance deductible 
  • Late payments and unpaid balances on your lease or loan for a vehicle 
  • Security remittances 
  • Indefinite warranties 
  • Contingent balances from prior loans or leases 
  • High mileage or excessive use fines for lease 
  • Expenses related to the loan’s credit insurance 
  • A deposit for a brand-new automobile

Costs of gap insurance

According to a Forbes Advisor review of gap insurance costs at major insurance firms, gap insurance raises the price of your monthly auto insurance by an average of $60.

Additionally, you can remove gap insurance from your policy when you no longer require it because your loan balance is about equal to or less than the value of your vehicle.

When compared to a car dealership, gap insurance is far less expensive than an auto insurance company. Although it might seem easier to purchase gap insurance from a car dealership, doing so is frequently more expensive in the long run.

According to Trusted Choice, a network of independent insurance agents, car dealerships routinely charge up to $600 for gap insurance for a year.

You may be able to add the cost of gap insurance to your auto loan, but doing so will result in interest charges. Since the fact that your gap insurance is linked to your loan, you will also lose the ability to cancel it, which means you risk paying for unnecessary coverage.

How much is gap insurance?

The Insurance Information Institute estimates that gap insurance typically raises your yearly rate by $20. 

Additionally, you can remove gap insurance from your policy when you no longer require it because your loan balance is about equal to or less than the value of your vehicle. 

When compared to a car dealership, gap insurance is far less expensive than an auto insurance company. Although it might seem easier to purchase gap insurance from a car dealership, doing so is frequently more expensive in the long run. According to Trusted Choice, a network of independent insurance agents, car dealerships routinely charge up to $600 for gap insurance for a year.

You may be able to add the cost of gap insurance to your auto loan, but doing so will result in interest charges. Due to the fact that your gap insurance is linked to your loan, you will also lose the ability to cancel it, which means you risk paying for unnecessary coverage.

Alternatives to gap insurance

Some auto insurance providers offer additional forms of protection that resemble gap insurance. Here are two gap insurance substitutes that you might find interesting.

New car replacement coverage

The new car replacement policy pays you enough to buy a new car in place of your totaled or stolen one. 

If you have this coverage, the insurance provider reimburses you with enough money to buy a new car instead of giving you the car’s depreciation-adjusted real cash value. To be eligible for new car replacement coverage, your car must fulfill age and mileage restrictions.

The new car replacement policy typically has a deductible.

As you can see, new car replacement coverage differs substantially depending on the business, so if you want new car replacement insurance, make sure to read the fine print and comprehend exactly what you’re receiving.

Better car replacement coverage

Better car replacement coverage is available from a few auto insurance providers. With this, you can replace your totaled car with a newer or better one. There can be mileage restrictions for this coverage. 

Policyholders who purchase a better car replacement program are given a car that is one model year newer and has 15,000 fewer miles. Here is one instance. Consider a 2020 vehicle that has 30,000 miles on it and is totaled. With the help of this coverage, the insured might purchase a 2021 model of the identical vehicle with 15,000 miles on it.

Only policyholders who own their vehicles are eligible for the extra coverage. Cars that are leased cannot use it.

If you owe a lot more on your automobile loan or lease than the vehicle is worth, the relatively low cost of gap insurance from an insurer can be worthwhile. 

You might choose to forgo gap insurance if you have enough money and don’t care about the “gap.”

Rehan Saleem

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