Gap InsuranceGap Insurance Coverage

Average auto loan payments in the U.S. are $563 per month, and the average loan term is 70 months or just over five years. Unless you made a sizeable down payment, chances are, you will owe more on that loan than your car is worth. That becomes a problem if a purchased or leased car is totaled, and your auto insurance only covers your car's depreciated value.

Gap insurance solves this problem. Here is an overview of gap insurance and why you should make sure you have it in your auto policy.

What is Gap Coverage?
Gap insurance coverage pays off your loan or lease if your car is totaled or stolen and its value is less than the amount you owe. You may purchase it as guaranteed auto protection, or your lender may require it.

This situation is typical because your new or used car depreciates quickly. Depending on your automobile's make and model, you can lose nearly 30 percent of its value in the first year and watch that value continue to decline. Depreciation creates a situation where most cars are "upside-down," meaning people hold negative equity in their vehicles.

If your leased or purchased car is totaled, conventional auto insurance covers your car's cash value (ACV) rather than the loan. If you hold negative equity, you suddenly have a terrible situation. Insurance proceeds make a partial payment toward your loan, you still owe a balance on your loan, and replacing your car becomes challenging. You can avoid this if you buy gap coverage before you finance and buy a new car or lease a vehicle.

Car Insurance with Gap Coverage
Car insurers include the following in their basic auto insurance policies:

  • Bodily injury liability. This coverage pays the medical bills and damages for passengers, pedestrians, bicyclists, and anyone else injured by your driving. States require this coverage, and minimum coverage may vary by state.
     
  • Personal injury protection (PIP). Also called medical payment coverage, PIP covers injuries to you or your passengers if you drive your car. It may also cover lost wages and coverage of needed services, like in-home nursing or house cleaning.
     
  • Property damage liability. If you damage another person's property while driving, this coverage kicks in. It includes fixing damaged vehicles but also buildings, fences, and other structures.
     
  • Collision. This coverage addresses damage to your car when you collide with another vehicle, telephone pole, tree, or any other object, or if you flip your car over. Auto insurance companies sell it under a separate deductible.
     
  • Comprehensive. This area addresses damage to your vehicle that has nothing to do with collisions with cars or objects. You use this coverage if someone steals your car or if your car sustains fire, flood, earthquake, or other damage beyond your control. If you hit a deer or sustain a cracked windshield, comprehensive coverage addresses that too.

    Like collision insurance, insurance companies place it under a separate deductible.
     
  • Uninsured and underinsured motorist. You use this coverage if the other driver in the accident does not carry insurance or carries low limits. It also helps if you become a hit-and-run victim.

    Gap insurance is supplemental to these policy basics, and you must request it. We recommend carrying gap coverage only if you are upside-down on your loan. See if that is the case by checking your car's value on Kelley Blue Book or National Auto Dealers' Association.

    However, some companies only add gap insurance on new cars. If you have an older vehicle, see if your insurance coverage provides alternative coverage like loan/lease payoff, new car replacement, or better car replacement.

What Does Gap Insurance Cover?
Gap insurance covers the amount owing on an auto loan or leases after comprehensive and collision coverage pays out. Depending on your auto insurance company, gap insurance may also cover deductibles.

How Does Gap Coverage Work?
Gap insurance works by making up the difference between your car's value and loan balance.

For example, let us say you purchase a new Subaru for $30,000. You took advantage of a dealership offer and only made a $4,000 down payment, so you finance $26,000.

When you drive off the lot, your car loses 20 percent of its value, meaning by the time you arrive home, your car is worth $24,000, and you already face negative equity of $2,000. One week later, someone t-bones you at an intersection. If you only carry collision and comprehensive coverage, no gap insurance, your insurance determines the car's cash value and settles the claim for that amount.

We will assume there is no deductible on the policy for simplicity's sake. Now, your once-new car is worth $24,000. Your insurance company pays that $24,000, which goes to your lender. However, since your loan is $26,000, you still owe them $2,000.

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However, if you buy gap insurance, your car is still assessed at $24,000, and your insurance company pays that claim. But in addition to that, they also pay the $2,000 outstanding and close your auto loan. Even if you do not have car replacement coverage, you are in a better place to purchase a replacement vehicle.
 

Is Gap Coverage Worth It?
You need gap coverage for the following:

  • Your lender requires it.
  • Your down payment on the vehicle was 20 percent of the purchase price or less.
  • You agreed to a finance term of 60 months or longer.
  • Your vehicle lease requires it.
  • You chose a make and model that depreciates quicker than average.
  • Your new car loan rolled over negative equity from a previous car loan.

The comparatively low price of gap insurance coverage is often worth it if you see four-figures of negative equity. If you made a down payment closer to 20 percent, you could likely get away with maintaining gap insurance for the first few years of the loan and drop it as you pay it down below your car's equity.

However, before you make that decision, check your car's value first and compare it to your current loan balance. You can find reliable car valuations on Kelley Blue Book or National Auto Dealers' Association.

How Do I Know if I Have Gap Insurance?
Confirm whether you carry gap insurance by calling your insurance agent. If you do not have it, ask if you can buy gap insurance and enjoy full coverage in the event of an accident.

Gap Coverage Cost
Gap insurance premiums are usually five to six percent of the collision and comprehensive coverage premiums. If your annual premium for this coverage is $795, expect gap coverage to cost $39.75 to $47.70. Sometimes, you can get a good insurance deal and pay as little as $20 per year.

Where to Buy Gap Insurance
You can get gap insurance from a dealership when financing your car or add it to your current auto insurance policy. It is usually less expensive if you go through your auto insurer since a dealership gap insurance ties it in with extended warranties that add to your loan payment. That option means paying interest in addition to that premium.
 
If you know your car is worth less than your loan balance, investigate gap insurance as soon as possible. This expanded car insurance coverage makes a big difference if you face a total loss and few options to replace it.

Hope that helps!

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At your service,
Young Alfred