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

Most people are thrilled when a bank or leasing company greenlights their application for a new auto lease or loan. Banks and lending companies require people to get full coverage when they finance their cars.

Unfortunately, this insurance coverage won't pay off the remainder of their loan if an unexpected accident totals their car, or a thief steals their brand new vehicle. A settlement only pays for the actual cash value ACV of a vehicle, which may not pay for the remaining balance on their loan.

When you are in an accident that is not your fault, the liability insurance of the other driver covers the worth of your car.

Will gap insurance cover the remaining amount on a lease or loan? Yes in this article, we'll discuss how this insurance can protect you.

What's an Upside-Down Loan?

If you buy a new car, you must be very careful. A car is never worth as much as it is the moment you drive out of the car dealership. It depreciates rapidly in value the moment you take off. Within seconds, the sticker price which you paid is just a memory.

Over time, you may find out that you have what's called an upside-down loan on your car. An upside-down loan is when you owe more money than what your car is worth.

Let's say you paid $35,000 for a vehicle and owe $30,000, but the car's actual cash value ACV (listed on Edmunds or Kelley Blue Book) is $25,000.

Insurers define the actual cash value (ACV) as the vehicle's replacement cost minus the depreciation of a damaged or stolen vehicle when it was stolen or totaled. If you totaled your car, your insurer would only pay you a $25,000 settlement.

The actual cash value ACV settlement would only cover $25,000 of the remaining $30,000 loan amount you owe, minus the $500 deductible. You would have to pay the remaining $5,000 out of pocket if you didn't have gap insurance.

You still have to pay off the balance, even though your vehicle no longer exists.

How Did I End Up with an Upside Down Loan?

There are several reasons why you may have an upside-down loan.

  • Reason One: You may have paid much more than the manufacturer's suggested price.

  • Reason Two: You may have paid less than 2% or even zero down when you leased or financed the vehicle.

  • Reason Three: You purchased an extended warranty that may have pushed you over the edge too.

  • Reason Four: You may have totaled the vehicle soon after you bought it.

The first few payments made on a vehicle 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.

An upside-down loan is when you owe more than what your car is worth.

People who drive over 15,000 miles a year also see heavy depreciation in their car's worth and find out they're in a bind after an accident.

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What Is a Gap Insurance Policy or Total Loss Replacement Coverage?

What does gap insurance cover? According to the Insurance Information Institute, guaranteed asset protection (gap) insurance pays off the remaining balance on upside-down loans. This supplemental insurance covers the difference between the car's value and the remaining lease or loan balance when your car is stolen or totaled. This insurance is also known as total loss replacement coverage.

Car insurers will usually make you purchase comprehensive and collision insurance before you can buy gap insurance.

Do I Need to Buy Gap Insurance if I Have Full Insurance Coverage?

Most states mandate drivers carry minimum liability coverage by law. Full coverage includes your area's required coverage plus comprehensive and collision coverage.

Finance companies or banks typically ask individuals to get full coverage for their vehicles under their loan terms.

Car owners may purchase gap insurance in addition to a full coverage policy. If you only made a small down payment on your vehicle, gap insurance will pay off the remaining balance of your loan after the insurance company pays a settlement if your car is stolen or totaled. Remember that the actual cash value ACV will not cover you in full because a car depreciates greatly after it leaves the dealer lot.

How Does Gap Insurance Work?

Gap insurance works by bridging the gap between your insurance settlement and the remaining amount of your loan balance.

Using a previous example, an insurance adjuster paid you the actual cash value for your totaled car and not the $30,000 balance remaining on your initial $35,000 car loan.

The settlement you received doesn't cover the entire car loan. If you had gap insurance, the insurance company would cover the insurance gap, the remaining $5,000, and you wouldn't have to pay this money out of your pocket.

Individuals should remember that the car insurance company will send the settlement reimbursement directly to your auto lender to pay off your totaled (or stolen) car.

Pay for different coverage if you want to get a replacement for your new car altogether. Some insurers, like Allstate, sell insurance policies that replace brand new vehicles.

Do I Need Gap Insurance?

You don't have to purchase gap coverage if you haven't financed your vehicle, but purchasing a gap insurance policy may still be a good idea, depending on how much you drive each year and how quickly your vehicle depreciates.

Some cars may depreciate as much as 20 percent during the first year someone owns them. People who don't make significant down payments on their vehicles can have car payments that exceed the vehicle's value.

Some cars may depreciate as much as 20 percent during the first year someone owns them.

Gap coverage is a great choice if you fall into the following categories:

  • You are a high-mileage driver
  • You bought a vehicle that will depreciate quickly
  • You have a finance period longer than 48 months
  • You made a small down payment, typically less than 20 percent
  • You lease your vehicle

Your loan has a high-interest rate because it will take longer to pay off the principal.

When Should You Buy Gap Insurance?

Consider buying gap insurance within the first 30 days of purchasing a new vehicle or certified used vehicle. Afterward, you can only renew this coverage for an additional three years.

Some insurers will require you to abide by the following guidelines to get gap insurance coverage:

  • The vehicle must not be older than two or three years old
  • You must be the car's original owner

After the insurance company no longer considers your vehicle as "new" your gap coverage will expire. An insurer may ask you to drop this coverage when it's time to renew.

Where Can I Buy Gap Insurance Coverage?

You can purchase gap coverage using one of three ways:

  • Your auto insurer may sell gap insurance coverage as part of an insurance policy.

  • An independent company can sell gap insurance for an upfront fee.

  • A dealer or lender can bundle gap insurance into your auto loan payments. This option is the most expensive since you'll pay interest in addition to your gap insurance fees.

How Much Does Gap Insurance Cost?

Gap insurance can settle outstanding debts; however, you should never buy this coverage from a car dealership. If they realize you owe more than what the car is worth, they'll try to sell it to you or email you after the purchase, but it'll be much cheaper to buy it elsewhere.

Lenders and dealerships charge the highest prices for the same coverage that you can get from an insurance agent.

Lenders and dealerships charge the highest prices for the same coverage that you can get from an insurance agent. It's not better coverage either, just more expensive.

They may charge a one-time fee of $500 - $700 for gap insurance. Unfortunately, this price rises over the life of the auto loan because you'll pay interest on your vehicle.

Stand-alone gap insurance can cost you $300 for an upfront fee.

The cheapest option is to purchase your gap insurance from an insurance carrier. Your car's value usually determines how much you'll pay for gap coverage.

Gap insurance may cost as low as $5 if you purchase it from an insurance company. Other policies can run from $20 - $40 annually.

How Does Gap Insurance Work? Does It Cover Older Vehicles?

If you have insurance, gap coverage may be hard to buy if you wait too long. Most insurance carriers only allow drivers to buy gap insurance when they first purchase a new vehicle or certified used car. These vehicles must not be over two or three model years old. Older vehicles do not qualify for this coverage.

Is Gap Insurance Worth It For Me?

You can estimate the potential value of your gap insurance coverage by using the following calculations.

  • You can visit sites like Edmunds or Kelley Blue Book to find the current value of your vehicle. Calculate how much depreciation similar vehicles have per year and what your car may be worth once you pay off your loan or lease.

  • Review the terms of your loan agreement to find out how much you'll owe in payments after each year of ownership. Compare this against your car's estimated current value.

  • Estimate how much you'll pay in gap insurance during those three years.

  • Compare your calculations. It will include the difference between your car's value and the remaining amount you'll owe in payments. It is the amount of gap coverage you'll need to keep from paying out of pocket for an upside-down loan.

Your gap coverage down payment should not cost you more than student loans. Some people use credit cards to buy it upfront, but you risk paying high interest rates. It's cheaper to add it to your existing policy.

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Alternatives to Gap Insurance

Do I need gap insurance? You don't have to purchase gap insurance to protect your vehicle investment. You can also use the following alternatives if you owe more than the car's actual cash value:

Loan/lease Payoff Coverage – Unlike gap insurance, this coverage is available for both new and used cars. It pays a percentage of your car's value, which is usually around 25 percent, in addition to your claim check, instead of a debt balance. Some insurers use loan/lease payoff coverage as an interchangeable term with gap insurance. This policy will pay off your loan or lease balance.

Esurance and Farmers offer this coverage.

New Car Replacement Coverage – Are you are worried about replacing your new vehicle and not just paying it off? This coverage will help you to buy a replacement vehicle in the same make and model year as yours. You'll only need to meet your deductible to get coverage. This coverage is only available for new cars and is not the same as gap insurance.

Allstate, Farmers, Liberty Mutual, Safeco, Shelter Insurance and Travelers offer this car insurance coverage.

Better Car Replacement – This auto insurance policy is available to car owners who own used cars and don't qualify for new car replacement or gap insurance. Companies that offer this coverage include Acuity, Chubb, Erie, Hanover, and Liberty Mutual.

Which Car Insurance Companies Sell Gap Insurance?

The following auto insurance companies sell gap insurance to customers.

  • State Farm – The insurance company offers a product similar to gap insurance called a Payoff Protector. It's available for people who get a car loan from a State Farm Bank (associated with U.S. Bank). Banking customers must have full coverage insurance. The bank doesn't require the insurance policy to be underwritten by State Farm. This program is available at no extra cost to State Farm Bank car loan customers.

  • Allstate – The program bridges the gap between primary auto insurance settlements and the remaining balance on a car loan up to $50,000. Allstate subtracts your deductible amount from the insurance settlements.

  • Nationwide – This auto insurance company offers gap insurance but requires customers to pay their deductible before coverage kicks in.

  • AAA – It provides gap coverage for fully insured vehicles. The insurer will sometimes waive deductible amounts up to $1,000 for vehicles that are total losses.

  • Esurance – This insurer offers loan/lease coverage for people leasing or paying off financed vehicles with full insurance (which includes a comprehensive and collision insurance policy).

  • USAA – This company offers Total Loss Protection for vehicles less than seven years old with car loans of $5,000 or more. They will reimburse deductibles up to $1,000. This company only offers insurance coverage to current military members, veterans and their families.

Making SmartFinancial Decisions About Auto Insurance

The first step in being a wise driver is having the right insurance. What's the point of paying for some insurance but not the products you need? Make sure you have a knowledgeable and trustworthy agent working for you to determine if gap coverage is the right type of coverage for your new vehicle. SmartFinancial's free online comparison tool can help you save money. Just enter your zip code below, and connect with an agent in your local area offering you the best value car insurance.

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