How Does Gap Insurance Work?

Fran
Lucy Lazarony
January 29, 2021

It’s important to consider whether or not you’d be obligated to pay for damages even if you have insurance. This could happen if your car is worth more than what you owe. You can see if you owe more on your car loans than its market value by visiting Kelley Blue book to see what your car is worth. You can then compare it with what you owe. Which is more? If your outstanding balance is more than what similar cars are selling for on the market, you may need Gap insurance.

Gap insurance is an optional car insurance coverage for new car and new leasing customers. Gap insurance will pay off your car loan or car lease if your car is totaled or stolen and if you owe more on your loan or lease than the car’s current, depreciated value. What is the gap in gap insurance? The gap exists between the amount you owe on a loan or lease and a car’s depreciated value.

Paying off the loan or lease with gap coverage can help you out of a tricky financial spot. And it is one that is fairly common for new vehicle owners. Most cars depreciate by as much as 20 percent in their first year of ownership so it is easy to be owing more than a car is worth in the first years of a lease or loan. Let’s take a closer look at gap insurance and how it works.

Who Can Buy Gap Insurance?

Gap insurance, also known as guaranteed asset protection, is only available if you are the original owner or have an original lease on a brand-new vehicle. Gap insurance is not available on used vehicles with previous owners. But you can purchase gap insurance on brand-new cars, trucks and SUVs.

Why Buy Gap Insurance?

As mentioned, gap insurance can get you out of a tight financial spot. And it works in tandem with two important insurance coverages, collision insurance and comprehensive insurance.

Both collision insurance and comprehensive insurance are optional coverages but they are required if you carry a loan or a lease on a car.

Collision insurance is coverage that helps to repair or replace your car if it is damaged in an accident with another vehicle or object such as a fence, a tree or a guardrail. Comprehensive insurance covers events not covered by collision insurance. These events include fire, theft, vandalism and damages from weather such as a windstorm, a hailstorm, a tornado or a hurricane.

A totaled car means that a car’s repair costs are greater than the value of the vehicle. And if your car was totaled in an accident, collision insurance would pay for the car’s covered damages up to the car’s depreciated value minus your deductible. This is where Gap insurance may come in. Your policy may not cover enough of the outstanding loan debt with the claim payout from your collision insurance, which will only give you the market value of your car today.

If your car was stolen, your comprehensive insurance would pay for your covered loss up to your car’s depreciated value minus your deductible. Again, the same would apply here. If a thief stole your car, you’d only get back the value of your car today and you may owe more to the lienholder of the vehicle.

Gap insurance is the final piece of the puzzle, paying the difference between what you owe on a loan or a lease and your car’s depreciated value.

Gap insurance covers the worst case scenario for new car owners and new lease drivers. Your vehicle gets totaled or stolen and you are left owing more than what you own on the loan or lease. Again, Collision insurance and Comprehensive insurance will cover up to the depreciated value of the totaled or stolen car. With gap insurance paying the difference you are all set.

How Does Gap Insurance Work?

Let’s look at an example of how gap insurance works. Let’s say you buy a $24,000 car and a year later the car depreciated by 20 percent and is now worth $19,200. And you owe $21,000 on your car loan.

The car is totaled in an accident and the collision insurance coverage pays up to the car’s depreciated value of $19,200, minus your deductible. And since you are borrowing on the car, this money would go to your lender.

Next, your gap insurance steps in to pay the difference of how much you owe on the car, $21,000 and the car’s depreciated value of $19,200. In this instance, gap insurance would pay $1,800.

If you didn’t have Gap Insurance, you would still have to pay the remaining $1,800, and it would come out of your wallet.

Sold with New Car Replacement

Some insurance companies sell gap insurance together with another optional insurance coverage called new car replacement. With new car replacement coverage, if your car gets totaled, your car will be replaced with a new one, a brand-new car of the same make and model.

New car replacement works with stolen cars too. So if your car gets stolen, it will be replaced with a new car of the same make and model.

And the gap insurance will be doing its job paying the difference of how much you owe on your old car and your car’s depreciated value. So you’ll be free and clear financially from the loan on the totaled or stolen car.

For Brand-New Vehicles

Some insurance companies require a vehicle to be brand-new when you purchase gap insurance. But other companies may allow you to get gap insurance on other slightly older cars, as long as you are the original owner or have the original lease on the car.

Would you like to get gap insurance on a 1-year-old or 2-year-old car? Reach out to your insurance company and find out if they will allow you to purchase gap insurance. It’s definitely worth checking if you decide you want gap insurance after having your new car for a little awhile.

Gap Insurance Guidelines

The Insurance Information Institute recommends that you consider gap insurance if you made less than a 20 percent down payment on your vehicle and if your auto loan is 60 months or longer. In both of these scenarios, you are likely to owe more on the car than its depreciated value.

As for leased cars, many lease contracts include gap insurance. So check to see if gap insurance is already covered in your lease. You may not need to buy a separate, add-on policy. If it’s not on your declarations page, consider adding it on.

Where to Buy Gap Insurance

You can buy gap insurance from the finance company at the dealership or from an insurance company. Gap insurance at the dealership tends to be more expensive and it may get rolled into your loan or lease. If this happens, you’ll be paying interest on top of the gap insurance price. So reach out to your insurance company instead. You may get a cheaper price on gap insurance. And you don’t have to worry about paying interest charges on your gap insurance coverage.

Car Insurance and Gap Insurance

Make sure you’re getting a good rate on your gap insurance as well as the full coverage you may be considering for your car. It’s always a good idea to compare car insurance quotes, but it can be a time-consuming task if you call every insurer, and there are a lot of them. SmartFinancial can compare rates for you from over 200 companies, all with no fee, and you don’t even have to put down a credit card. You can start comparing rates by entering your zip code below.

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