What Is Gap Insurance and Do I Need It?

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The minute you drive off the dealer’s lot with a new car, it begins to depreciate. According to the Insurance Information Institute, most automobiles depreciate by 20% their first year on the road.

Collision and comprehensive auto policies only pay up to the actual cash value of your car. If you buy a new car for $30,000 and total it in the first year, the insurance company will only pay what it’s worth on the market; let’s say $24,000. If you total the vehicle three years into ownership, it will have depreciated even more, so the insurance company may only pay a claim equal to half its original purchase price.

Unfortunately, the scenario only gets worse. If you took out a $28,000 loan for the car and total it the first year, the amount of money the insurance company pays on your claim will not be enough to pay off the loan. The situation isn’t as dire as it might seem because gap insurance can help cover the difference between the amount of your claim check and the amount you owe the lender.

Gap insurance covers the difference between your car’s current market value and the amount you owe a lender. So, if your car has a depreciated value of $24,000 when it’s totaled, and the insurance company pays $24,000 on your claim, a gap policy will pay off the amount of money you still owe the lender.

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How to buy gap insurance

If you lease your car, the leasing company may include gap insurance in the lease agreement. In some cases, your collision and comprehensive policies may include gap insurance. It’s important to know if you already have the coverage. If you’re not sure, read your policy’s fine print or call your agent for more information.

You can buy gap insurance through an auto dealership, a car insurance company or lender. Typically, large carriers such as Allstate, Esurance, Nationwide and State Farm sell gap insurance as an add-on to your collision and comprehensive coverages. Some companies market their gap insurance using a catchy name. For instance, State Farm markets its gap insurance as Payoff Protector.

If you want gap insurance, check if your preferred insurance company offers the coverage because some don’t. For instance, Geico, one of the nation’s largest car insurance companies, doesn’t offer gap insurance.

Because automobiles start depreciating the moment the salesperson hands you the keys, it’s best to buy the coverage immediately for all leased and most financed vehicles.

How much does gap insurance cost?

Add-on coverages increase the cost of your car insurance. But gap insurance usually costs around $20 per year, according to the Insurance Information Institute. Car dealers often offer gap insurance to their customers. Even so, auto insurance companies often offer the cheapest rates for gap insurance.

Should I get gap insurance?

State laws don’t require you to purchase gap insurance. However, the coverage is reasonably priced, so it makes good financial sense to buy it in most cases.

When is gap insurance worth it?

Gap insurance is also important if you’re in certain situations.

If you lease a vehicle, the leasing company probably will require you to buy gap insurance and may include it in your lease agreement. Typically, leased vehicles are new, but because automobiles depreciate rapidly, the leasing company will require you to carry liability, collision, comprehensive and gap insurance to fully protect its property.

If you make a down payment of less than 20% of the purchase price, consider buying gap insurance.If you don’t make at least a 20% down payment, the car’s actual cash value may be lower than the amount you owe the lender the minute you drive away from the dealership.

The high sticker prices of today’s cars make long finance terms attractive to many automobile owners. It’s easier to afford payments on a 60-month loan than it is a 24-month loan. But each payment you make goes toward principal and interest. If you finance your car for more than two years, you need gap insurance because the difference between your car’s actual cash value and the amount you owe the lender will occur quickly, sometimes in the first year of ownership.

Before buying any vehicle, check Kelley Blue Book to see the resale history for your type of car. Some automobile makes and models depreciate faster than others do and are more difficult to resell. Used cars have a retail value and a trade-in value. Usually, the trade-in value is lower than the retail value. If you finance a vehicle that has a poor resale history or one that depreciates quickly, you need gap insurance.

When is gap insurance not worth it?

Your lease terms may require you to carry gap insurance as long as you have the automobile. But if you finance a car, you don’t need to carry gap insurance for the entire loan term. When the amount you owe dips below the actual cash value of the vehicle, you can discontinue gap insurance coverage.
And if you pay cash for an automobile, you don’t need gap insurance.

Bottom line

If you don’t want to worry about something happening to your car while you’re still paying for it, gap insurance can be a worthwhile investment. Check with your prefered insurance provider to see if you can add gap insurance to your current plan or cover a new vehicle purchase.