If you recently applied for a car loan, the dealership most likely gave you the option to purchase gap insurance on your vehicle. Gap insurance pays off the loan balance if your car is stolen or totaled in an accident.
Gap insurance is relatively inexpensive, but is it worth the cost? That depends on multiple factors, including the price, coverage options, and available providers. This blog post will review how gap insurance works and who should buy this type of coverage.
What is Gap Insurance?
It’s common knowledge that cars begin depreciating in value the minute you drive them off the lot. And if you take out an auto loan, that means the resale value will often depreciate to less than what you owe on the loan.
Assuming the vehicle is working well and you keep it for the next five to ten years, that may not be a problem for you. But what if you get in an accident next week and another driver totals your car?
Insurance will pay you the actual cash value (ACV) of the vehicle, but you’re still responsible for paying off your car loan. How do you make up the difference in what you owe?
That’s where gap insurance comes into play. Gap insurance pays the difference between the ACV and the amount you currently owe on the loan. That way, you’re not stuck buying a new car and paying off the balance on your previous auto loan.
How Gap Insurance Works
Let’s say you take out an auto loan for $30,000, and a year later, your car is totaled in a car accident. At the time of the accident, your vehicle is worth $20,000.
After you pay your $1,000 deductible, the insurance company pays you $19,000. The problem is, you still owe $11,000 on your previous auto loan. Not only that, but you also have to buy a new car. This puts you in a difficult situation financially.
But if you have gap insurance, your policy will pay off your $11,000 auto loan. Now you can use the insurance payment to purchase a new vehicle.
Who Needs Gap Insurance?
If you always pay for your car in cash, then you do not need gap insurance. Gap insurance is for individuals that take out auto loans to purchase their vehicle.
But even if you do take out an auto loan, there’s a chance you don’t need to purchase gap insurance. Here are some situations where gap insurance is a good idea:
- You lease your car (Gap insurance is usually a requirement for leased vehicles)
- You took out an auto loan for five years or more
- You made less than a 20% down payment
- The vehicle you purchased depreciates faster than other cars
- You rolled negative equity from a previous car loan into the new loan
However, once the amount you owe on the loan is less than what the car is worth, you no longer need gap insurance. For instance, if you owe $10,000 on your auto loan and the car is worth $15,000, there’s no option for a gap insurance payment.
You can use an online pricing guide like Edmunds or Kelley Blue Book to determine your vehicle's current value.
How Much Does Gap Insurance Cost?
If you need to buy gap insurance, the good news is that it’s pretty inexpensive. According to the Insurance Information Institute, it usually only costs about $20 per year to add this to your annual premium.
However, the exact cost will vary depending on where you live, your age, and your driving record. The make and model of the vehicle will play a role in the price as well.
Where Can I Buy Gap Insurance?
There are multiple ways you can purchase gap insurance. The easiest way is probably to purchase it through your current insurance carrier as an add-on coverage. You can also buy it through your dealership or lender when you take out the auto loan.
Some lenders require gap insurance, so your lender may include it in the total loan price. You can also make a one-time purchase from a company that solely sells gap insurance.
If your insurance company doesn’t offer gap insurance, here are some other providers you can consider:
- Progressive
- Nationwide
- State Farm
- Allstate
- Liberty Mutual
- Traveler’s
- American Family Insurance
Alternatives to Gap Insurance
Gap insurance isn’t the only way to protect yourself financially. You can also upgrade your insurance policy to add New Car Replacement coverage.
This policy is available for vehicles less than a year old that have fewer than 15,000 miles. If your car is totaled during the first year of ownership, you’ll receive money for a replacement that’s the same make and model as your current car.
Gap insurance pays for the gap between what the vehicle is worth and what you owe on your car loan. With New Car Replacement insurance, you won’t even have to apply for a new car loan. You’ll receive a new car, and continue making payments on your current loan.
However, this policy isn’t available for leased vehicles. If you’re looking to lease a car, you can also consider purchasing lease payoff coverage. This coverage pays out a percentage of your car’s total value in addition to the claim check.
The Bottom Line
If you’re financing or leasing a car, gap insurance may be a good choice for you. If you owe more on the car than it’s currently worth, gap insurance can protect you if the vehicle is totaled or stolen. Your best bet is to contact an insurance agent who can explain your options to you.
