Should I Buy Gap Insurance? What Is it, Anyway?

Fran
Fran Majidi
February 14, 2019

Often, when people buy an expensive new car they buy the best car insurance with the highest limits and lowest deductibles. They make sure to have collision, comprehensive and even uninsured motorist protection on their brand new car. After all, they picked out the best car in the lot with all the bells and whistles! They pay a hefty price for the car but they figure that with full insurance, they’ll be fine if something goes wrong (i.e an accident). Is it that simple though?


If you buy a new car, you must be very careful. And you need to understand the worth of the car in insurance terms. A car is never worth as much as it is the moment before you drive out of the car dealership. In fact, it depreciates incredibly fast the moment you take off. Within seconds, the sticker price which you paid is just a memory.


When you are in an accident that is not your fault, the liability insurance of the other driver covers the worth of your car. The worth of your car has nothing to do with what you paid for it. The value is reflective of the huge depreciation that took place as soon as you left the dealership lot. Your car’s value is based on Kelley Blue Book numbers, which may surprise you. In fact, you may find out that you have what’s called “an upside-down loan” on your car. What does this all mean? We’ll tell you.


What’s an upside down loan?

An upside down loan is when you owe more than what your car is worth. Let’s say you paid $35,000 for a car and owe $30,000 but the Kelley Blue Book value of the car is $25,000. You owe $5,000 more than what the car is worth. You may say you don’t care and that it’s fine. You love the car. You wouldn’t want another one, etcetera. But what if you totalled your beloved car? Regardless of all the emotional reasons you agreed to pay the exorbitant sticker price, the fact remains that your car is worth less than what you owe, and if you crash it you’ll be paying for it.


Let’s say you totalled it. Yes, you were wise and bought all the right insurance but let’s look at how this upside down loan is going to still haunt you. After the claims process was finished, you were paid out the entire value of your car ($25,000) minus your $500 deductible. But, you still owe $5,000 because that was the discrepancy between what you owe and what the car is worth.


You still have to pay off the balance, even though there is no car any longer. Ouch!


How Did I End Up with an Upside Down Loan?

You may have paid much more than the manufacturer’s suggested price. Or, you may have paid less than 2% or even zero down when you leased or financed the car. If you purchased an extended warranty, that may have pushed you over the edge too. Or, you may have totalled the car soon after you bought it. The first few payments made on a car usually cover very little more than taxes and interest. If you have 60 or more loan payments you may be in an upside down loan as well. People who drive more than 15,000 a year also see heavy depreciation in their car’s worth and find out they're in a bind after an accident.


Gap Insurance or Total Loss Replacement Coverage

If you’re going to be a car lover and make emotional buying decisions, you should at least be responsible so that you don’t find yourself in a financial pickle. One way you can do this is to buy gap insurance, also called total loss replacement coverage, depending on the carrier. What this coverage does is it covers the remaining balance on upside down loans. Yes, if you had this type of coverage, that remaining $5,000 would’ve been covered and you would not be reaching into your own pocket.


This coverage can easily settle outstanding debts. However, you never want to buy this coverage from a car dealership. If they realize you owe more than what the car is worth, they will try to sell it to you. However, you are probably paying double (or more) for the same coverage that you can buy from your insurance agent. It’s not better coverage either, just more expensive.


One more important point about gap insurance or total loss replacement coverage: you can only add this on within the first 30 days of buying a new car. It’s only valid for three years after that.


SmartFinancial Decisions

The first step in being a wise car owner is having the right insurance. What’s the point of paying for some insurance but not the products that will save you so much grief? Make sure you have a knowledgeable and trustworthy agent working for you. If you don’t, we can help if you visit here.


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