You’ve been enjoying your new car and can’t wait to drive it to work. At an intersection in the middle of rush hour, a hatchback to your right runs a red light and T-bones your vehicle. Everybody in both vehicles is all right, but unfortunately, your sedan is declared a total loss. Its repair value would exceed the cost of the car.
You file a car insurance claim and your insurer takes care of paying off the value of your car to the lender financing your car. However, you receive a bill for 20 percent of the cost of the loan, which your policy did not cover. Due to depreciation, you owe more on your car than it is worth.
This is where gap, also known as guaranteed auto protection, insurance comes in.
Going Underwater
When you drive a new or leased vehicle off an auto dealer’s lot, it may depreciate by as much as 20 percent. After the first year, its value may go down by an additional 10 percent for a total drop of 30 percent.
If you do not account for this depreciation in your financing, your car loan will be underwater or have negative equity for the first two years. You’ll owe more on the car than it is worth. If your vehicle is totaled or you try to sell it, the compensation you receive will not be enough to pay off the loan.
One way to stay above water is to put money down that is equal to the expected depreciation. You can also trade in a vehicle that is worth more than the predicted value loss.
You can also avoid the negative effects of this depreciation through gap insurance coverage.
All about Gap Insurance for a Car
Gap insurance is additional coverage that you buy on top of comprehensive or collision coverage. If your vehicle is stolen or totaled, your comprehensive or collision policy would cover the cost of the loss up to the depreciated value of your car.
If the loan you owe on your car is greater than the depreciated value, gap insurance would cover the remainder, so you end up owing nothing.
For example, assume you finance a brand new sedan for $30,000. When you drive it off the lot, the car depreciates by 20 percent ($6,000) so it’s only worth $24,000. The next day, someone steals your purchase. Your insurer will only pay $24,000 of the auto loan.
- If you don’t have gap insurance, you’ll owe $6,000 out of pocket to pay off the loan.
- If you have gap insurance, it takes care of the $6,000.
In many cases, gap insurance is voluntary. However, some lenders may demand that you buy it for specific types of vehicles, such as luxury sedans, sporty SUV or trucks.
When Should You Consider Gap Insurance
When you buy or lease a new vehicle, you should consider gap insurance if you:
- Have no or less than 20 percent down payment.
- Finance the loan for 60 months or longer.
- Lease a car, which generally requires the insurance.
- Have an old car loan that isn’t paid for but is being rolled into the new car loan.
- Buy a vehicle that depreciates faster than average. US News & World Report states that for 2021, vehicles that went down in value the fastest in the previous five years include the BMW X3 (66.5 percent), Mercedes-Benz S-Class (67.1 percent), Audi A6 (69 percent), the Nissan Leaf (70.1 percent), and the BMW 7 Series (72.6 percent). Note that these are all 2015 models because of the time involved.
When to Skip Gap Insurance
You may consider skipping gap insurance if you:
- Made a down payment of at least 20 percent or your trade-in is worth at least 20 percent.
- Have a loan term of 60 months or less.
- Have a vehicle that holds its value. US News & World Report states that for 2021, vehicles that depreciated the least include the Nissan Frontier (43.5 percent), Dodge Challenger (40.6 percent), Toyota 4Runner (38.5 percent), Porsche 911 (36 percent), and the Jeep Wrangler Unlimited (30.9 percent). All these are 2015 models.
- Have had the loan long enough for what you owe on the vehicle to be worth more than its value. You can periodically check the value of your car on Kelley Blue Book. If it’s more than what you owe, you can drop gap insurance.
Cost of Gap Insurance
When you have a comprehensive car insurance policy, gap insurance can cost as little as $20. But just like car insurance coverage, the cost can differ according to your state, age, make and model of the vehicle, and driving record. Insurers generally offer the cheapest option while dealers may charge more. As with other costs, it pays to shop around for this type of car insurance.
What Else Does Gap Insurance Cover?
Gap insurance covers damage to your vehicle and theft but nothing else. It does not cover property damage, bodily injury, death, or engine trouble. You will also still owe your deductible. Using the previous example, if the payment on your gap claim is $6,000 and the deductible is $500, you would need to pay the $500 out of pocket before gap insurance covers the remaining $5,500.