Purchasing a new car is an exciting experience, but it also comes with financial considerations, particularly when it comes to insurance. Beyond the standard auto insurance coverages, you might encounter terms like “gap coverage.” But What Is Gap Coverage On A Car, and why might you need it? Gap insurance, short for Guaranteed Asset Protection insurance, is an optional auto insurance coverage designed to protect you financially if your car is totaled or stolen and you owe more on your car loan or lease than the vehicle’s actual cash value (ACV).
Let’s illustrate with an example. Imagine you’ve just financed a brand-new car. Fast forward a couple of years, and unfortunately, your car is involved in a major accident and is declared a total loss by your insurance company. While your collision coverage will pay out the car’s actual cash value at the time of the accident, cars depreciate quickly. The ACV of your car might only be $18,000, but you still owe $22,000 on your loan. This leaves a $4,000 “gap” between what your insurance pays and what you still owe. This is precisely where gap coverage steps in. It can potentially cover this $4,000 difference (minus your deductible), preventing you from being stuck paying off a loan for a car you no longer own. Gap insurance doesn’t cover the original purchase price of the vehicle, but rather the outstanding loan amount at the time of a covered loss. It’s a valuable addition to your auto insurance portfolio, especially when combined with collision coverage.
Understanding How Gap Coverage Works
Gap coverage is relatively straightforward. It operates when there’s a significant difference, or “gap,” between your car’s actual cash value and the outstanding balance on your loan or lease.
What Does Gap Coverage Cover?
Gap insurance primarily covers the financial gap in two main scenarios:
- Total Loss Accidents: If your car is totaled in a covered accident, meaning the damage is so extensive that it’s not worth repairing, gap insurance can cover the difference between the ACV and your loan balance.
- Vehicle Theft: Similar to a total loss, if your car is stolen and not recovered, gap coverage can help pay off the remaining loan amount after your comprehensive insurance pays the ACV.
It’s important to note that gap insurance typically doesn’t cover:
- Vehicle Repairs: Gap insurance is not a substitute for collision or comprehensive coverage, which cover repairs for accidents or other damages.
- Personal Injury: Gap insurance doesn’t cover medical expenses or injuries resulting from an accident.
- Property Damage: It doesn’t cover damage you cause to another person’s property.
- Deductibles: You’ll still be responsible for your deductible on your underlying collision or comprehensive policy.
- Loan Defaults or Overdue Payments: Gap insurance doesn’t cover your loan payments if you can’t afford them or if you default on the loan.
- Items Not Financed: It only covers the vehicle itself, not aftermarket accessories or extended warranties that were not part of the original financing.
Actual Cash Value (ACV) vs. Loan Balance
To fully grasp how gap coverage works, understanding ACV is crucial. Actual Cash Value is the fair market value of your car at a specific point in time. It takes into account depreciation due to age, mileage, condition, and market factors. Insurance companies determine ACV to calculate payouts for total loss claims.
Your loan balance, on the other hand, is the amount you still owe to the lender. Especially in the early years of a car loan, the loan balance can decrease slower than the car’s depreciation, leading to a gap between the ACV and what you owe.
Gap insurance bridges this gap, ensuring you are not financially burdened by a loan for a car you can no longer use.
Is Gap Coverage Necessary for You?
Deciding whether you need gap coverage depends on your individual circumstances. Consider these factors to determine if it’s a worthwhile investment for you:
Scenarios Where Gap Coverage is Highly Recommended
- Financing a New Car: New cars depreciate rapidly in the first few years. If you’ve financed a new vehicle, especially with a small down payment or a long loan term, you’re more likely to be “upside down” on your loan, meaning you owe more than the car is worth.
- Long-Term Car Loans: Longer loan terms mean slower equity build-up. The longer it takes to pay off your loan, the greater the chance of a gap between ACV and your loan balance.
- Leasing a Vehicle: Leases often require gap coverage. Lessors want to protect their investment, and gap insurance ensures they are not left with a financial loss if the leased vehicle is totaled or stolen. Sometimes gap coverage is even included in the lease agreement.
- Rolling Over Negative Equity: If you traded in an old car with negative equity and rolled that amount into your new car loan, you immediately increase the gap between the car’s value and your loan.
- High Loan-to-Value Ratio: If your loan amount is a high percentage of the car’s value, gap insurance is more critical.
Scenarios Where Gap Coverage Might Be Less Necessary
- Large Down Payment: A significant down payment reduces the initial loan amount, lessening the likelihood of a substantial gap.
- Short-Term Car Loans: Shorter loan terms lead to faster equity build-up, reducing the time you’re “upside down” on your loan.
- Buying a Used Car: Used cars depreciate at a slower rate than new cars. If you’ve purchased a used car and financed it, the gap risk might be lower.
- Owning Your Car Outright: If you own your car outright or owe less than its ACV, gap insurance is not necessary as there is no “gap” to cover.
The Cost of Gap Coverage
The cost of gap coverage is generally quite affordable, especially when compared to the potential financial risk it mitigates. Several factors influence the premium:
Factors Affecting Gap Insurance Cost
- Vehicle Value: The higher the value of your car, the potentially higher the gap insurance cost.
- Loan Amount and Term: Larger loan amounts and longer loan terms can increase the risk of a gap, potentially affecting the premium.
- Location: Insurance rates vary by state due to different regulations and risk factors.
- Insurance Provider: Different insurance companies have varying pricing models.
Average Cost and Ways to Save
Gap insurance is relatively inexpensive. When purchased through your auto insurance provider, it can add just $20 to $40 per year to your premium on average. Purchasing it separately through a dealership or lender can be significantly more expensive, potentially costing $200 to $700 upfront.
Tips to save on gap insurance:
- Bundle with your existing auto insurance: Purchasing gap coverage from your current car insurance company is usually the most cost-effective option.
- Shop around: Compare quotes from different insurance providers to find the best rate.
- Re-evaluate coverage periodically: As your loan balance decreases and your equity increases, you may eventually no longer need gap coverage. Review your need for gap insurance annually and consider dropping it once the gap is closed.
Is Gap Coverage Worth the Investment?
For many car owners, especially those financing new vehicles, gap coverage is a worthwhile investment. The peace of mind of knowing you won’t be stuck with a loan for a car you can’t drive can be invaluable. While you hope never to use it, gap insurance provides a financial safety net in unfortunate circumstances like total loss accidents or theft.
If you are in a situation where you owe close to or more than your car’s worth, the relatively low cost of gap coverage is a small price to pay for significant financial protection. It’s a smart way to avoid potential financial hardship in the event of a car total loss or theft.
Where to Purchase Gap Coverage
You have a few options when it comes to purchasing gap coverage:
- Your Auto Insurance Provider: This is often the most affordable and convenient option. Contact your current car insurance company to inquire about adding gap coverage to your policy.
- Lenders and Dealerships: Car dealerships and lenders typically offer gap insurance as part of the financing process. However, this option is usually more expensive than purchasing it through an insurance company.
- Standalone Gap Insurance Companies: Some companies specialize in gap insurance. While these exist, they might not be as readily accessible or cost-effective as going through your existing insurer.
Recommendation: Start by checking with your current auto insurance provider. Bundling gap coverage with your existing policy is generally the most economical and straightforward approach.
In conclusion, understanding what is gap coverage on a car is essential for making informed decisions about your auto insurance needs. If you’re financing a new car, leasing, or have a long-term loan, gap insurance offers valuable financial protection against potential losses. While it’s an optional coverage, for many drivers, the peace of mind and financial security it provides are well worth the small additional cost.
References:
[1] https://www.caranddriver.com/car-insurance/a36534152/how-much-is-gap-insurance/, Accessed February 2022.
