When you buy or lease a car, you are required to pay for collision and liability insurance, and in the case of financed or leased vehicles, comprehensive insurance must be carried as well, until the terms of the loan or lease have been met. This is the standard sort of auto insurance with which we are all familiar.
Sometimes, however, a financed (including leased) vehicle will be damaged in an accident relatively soon after it is purchased. When this happens, the insured value of the car may be significantly less than the amount you still owe your lender or lease company. Gap insurance exists to cover this gap in value, so that if your relatively new car should be totaled, you can still pay off your lender and acquire a new vehicle.
How it Works
Let’s consider an example. You buy a new car for $25,000, with $1,000 down and loan payments of $400 / month. Five months later, your car is involved in a terrible accident. You’re physically okay, but the vehicle is damaged beyond repair and declared a total loss.
After reviewing your insurance claim, your insurer decides that even though your car is only five months later, it’s only worth $21,000. (Remember, this is only an example.) Your original loan amount was $24,000, and after five months, that’s only decreased to $22,000 – leaving a gap of $1,000.
Gap insurance covers that difference for you – the difference between what insurance will pay ($20,000), and what you still owe ($21,000). Without gap insurance, that extra $1,000 would have to come from you.
There is a slight catch: if your insurance company determines that you’re at fault, or in any other way responsible to pay your deductible, gap insurance will not cover the deductible amount.
That’s if you purchased a car with a loan.
If you leased your car, things are a little different.
Gap Insurance and Leased Cars
When you lease a car you still make a small down payment, but because you’re not actually buying the car, but renting it for a specified term, you’re likely to have lower payments than with standard purchase financing. This means that the difference between the value of the car and what you owe on your lease may be much larger than just $1,000. For this reasons, most leasing companies require gap insurance on all transactions.
Do I Need Gap Insurance?
If you leased your car, gap insurance is almost always required, and in some cases your lease company may actually provide it as part of your payment. If they do not offer in-house coverage, almost any reputable auto insurance company can handle your needs.
If you purchased your car with a loan, it depends on the value of the vehicle. If you bought a high-value car, or one that will depreciate more rapidly than usual, you may want to consider gap insurance, at least for the first year or so of your loan. After that, and for standard vehicles, gap insurance is rarely recommended.
If you bought your car outright, there is no gap to cover, because there is no loan to repay, so you do NOT need gap insurance.