Car owners can obtain gap insurance, a sort of auto insurance, to safeguard themselves against losses that may occur if the amount of compensation received in the event of a total loss is insufficient to pay off the amount the insured owes under the finance or leasing arrangement for the vehicle. When the outstanding debt on an automobile loan exceeds the vehicle’s book value, this situation occurs.
Breaking Down Gap Insurance
Consider John’s automobile, which is worth $15,000, as an illustration of gap insurance at work. However, he has outstanding car payments of $20,000 as of right now. John’s auto insurance coverage will pay him $15,000 if an accident or theft results in the total loss of his vehicle. John no longer has a car, but he still owes the auto finance business $20,000, therefore he will still be $5,000 short.
If John acquires gap insurance, the $5,000 “gap,” or the difference between the money received from reimbursement and the balance still owed on the car, would be covered by the gap insurance policy.
Situations for Gap Insurance
- You bought a car on credit with little to no down payment: You’ll be in default on your auto loan as soon as you drive off the lot if you don’t put down a sizable down payment. Before the loan balance and the car’s actual worth start to balance, it could take a while.
- You traded in an automobile that was upside down. If you don’t pay the difference in full upfront when trading in an upside-down vehicle, the dealership will add the remaining debt to the loan on the new vehicle. If your car is wrecked or stolen, this additional balance can come back to bite you.
- You purchased a vehicle with a low resale value: Without a sizable down payment, you would likely be upside down if you purchased a car that depreciates quickly. When we say “significant,” we mean at least 25%.
- You want to accumulate miles quickly: Few things lower a car’s value more quickly than frequent driving. The value of your automobile depreciates more quickly the more miles you put on it, and it’s possible that this will happen faster than your payments can keep up.
- A car loan with a longer term (greater than 60 months) has been obtained by you: The break-even point, which is reached when your loan debt and the car’s value start to equalize, is typically reached later with a long-term loan.
Guaranteed Auto Protection is referred to as “GAP” in the insurance sector. When the value of a loan taken out to purchase an automobile is larger than the car’s entire value, this form of insurance is only required temporarily. Should the car be totaled in an accident, the insurer would be responsible for paying the difference in value if there was gap insurance. This is not covered by standard auto insurance.
For instance, if you financed or leased a car with no down payment, the amount you borrowed might, for a while, exceed the overall cost of the vehicle. Standard auto insurance will only reimburse you the current value if the car is stolen or damaged in an accident, so you’ll lose money paying back the initial loan or lease. Gap insurance fills in this “gap” between the loan balance and the car’s depreciating value.
The kind of car you buy or lease will determine whether you require car gap insurance. But does gap insurance pay off? If you think you may owe more on a car than your comprehensive auto insurance coverage would cover if you made a claim, it might be the case.
- When the payment for a total loss is less than the remaining loan or lease balance, gap insurance, commonly referred to as guaranteed auto protection, reimburses the automobile owner.
- Only while the loan value exceeds the full worth of the vehicle being leased or financed is gap insurance necessary. Should the car be totaled in an accident, the insurer would be responsible for paying the difference in value if there was gap insurance. This is not covered by standard auto insurance.
- For those who chose a lengthy payback period and put no money down, gap insurance makes the most sense. They might owe more on the car than it is currently worth for a few years.
- For individuals who choose to lease a car rather than buy one, it also makes sense.
- If you put at least 20% down on the vehicle when you purchased it or are paying off the loan for the vehicle in fewer than five years, you might be able to forgo gap insurance.
- For as long as your loan debt does not exceed the value of the vehicle, you do not require gap insurance.
What Is Gap Insurance on a Car?
A supplemental auto policy called gap insurance pays for any discrepancy between the insured value of a car and the remaining loan or lease that the owner is required to pay. Gap insurance is required to reimburse the difference between your auto insurance payout and the balance owed on the car if it is totaled or stolen before the loan is paid off.
Your lender may mandate gap insurance if you’re financing the purchase of a specific kind of automobile, truck, or SUV. This specifically refers to automobiles like luxury sedans, SUVs, or specific other kinds of SUVs that may degrade and lose value at rates that are faster than average.
Depending on how much of a loan or lease you still owe on your automobile and how much the car is actually 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 financed the majority of your car and put down less than 20% on it when you took out a car loan that was five years (60 months) or longer.
- 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.
However, there is no incentive to have gap insurance once your balance is equal to or just more than the worth of your car. That’s because there won’t be much of a chance for a gap insurance payout. There won’t be a gap, for instance, if your loan balance is $15,000 and your car’s ACV is $17,000.
Is Buying Gap Insurance Worth It?
Find out how much is left on your auto loan before purchasing gap insurance. After that, you can make a comparison to the value of your car. You can use this to determine if you require gap insurance or not. Also advised by the Insurance Information Institute is gap insurance if you:
- Put less than 20% down on your vehicle.
- Plan to finance for at least 60 months.
- purchased an automobile that loses value more quickly than others
- carried over bad equity from a different car loan already
- Lease your vehicle, which typically necessitates gap insurance