How Does Gap Insurance Work?

July 23, 2019

Within the first year of car ownership, you lose 20 percent of the car’s value to depreciation. If you financed most of the cost of the vehicle, you could find yourself upside down rather quickly. If you have an accident and the insurance company totals your car, you may have to pay money out of your own pocket just to pay the loan in full.

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Gap insurance helps offset this ‘gap’ in coverage. If the insurance company totals your car, yet you owe more than the car’s worth, the gap insurance may cover the difference. Gap insurance is a separate ‘add-on’ to your insurance that you pay more for, but it could be worth it in the end.

Gap Insurance Coverage

Gap insurance covers the vehicle only. It’s not supplemental insurance for bodily injury or even property damage. It covers your vehicle only. The gap coverage equals the difference between the market value of your car and the amount you owe at the time you purchase the policy.

Gap insurance does cover accidents and theft. If you are in an accident that totals the car, gap insurance will kick in if necessary. It also works if a thief steals your car and the police are unable to recover it – this is another version of a total loss.

How Gap Insurance Works

Gap insurance is an add-on to your collision and comprehensive insurance. These policies cover the loss first. For example, if you are in an accident, your collision insurance would cover the loss. If you a thief stole your car, your comprehensive insurance would cover the loss. The gap insurance makes up the difference, if there is one between the coverage amount and the amount you owe on the car.

Keep in mind that gap insurance only covers the difference between the depreciated value of the car right now and the amount you owe the bank. You won’t walk away with any money in your pocket with the gap insurance, but you also won’t be on the hook to pay off the car loan on a car you no longer own.

Who Needs Gap Insurance?

As we said above, gap insurance isn’t a requirement and it doesn’t benefit everyone. It’s the right insurance for those that make a small down payment and finance the car for more than 60 months. A small down payment and long financing period make it more likely that you’ll be upside down on your loan, leaving you with a large financialresponsibly.

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Who Doesn’t Need Gap Insurance?

If you make a large enough down payment on your car or choose a short financial period, you don’t need gap insurance. Even if you do buy gap insurance initially, you won’t’ need it forever. Once you pay your car loan down enough, you will owe less than the car is worth. If an accident totaled your car, you would walk away with money in your pocket even after paying off the car loan.

Here’s an example:

You own a car that is worth $15,000. The outstanding loan balance on it is $9,000. Another driver hit you and caused severe damage to your car. The insurance examiner determined the car to be totaled. The insurance company issues you a check for $15,000. You pay the bank $9,000 and walk away with $6,000 in your pocket. While $6,000 won’t buy you a new car, it can help you with the down payment on your next car.

Where can you Buy Gap Insurance?

You have a few options when buying gap insurance. The first place you’ll come across it is at the car dealership when you buy your car. The dealer will likely encourage the purchase to protect your interest in the car, but it also benefits them as they make a decent profit on gap insurance.

If you don’t buy it at the dealership (which we recommend you don’t), you can buy it from your insurance company alongside your standard car insurance. Gap insurance from an insurance company typically costs less than it would cost at the dealership.

Gap insurance can help bridge the gap between the market value of your car and your outstanding car loan balance. It may cost up to 5% of the cost of your collision and comprehensive premium, which often means only a few dollars to your annual premium. While you won’t need gap insurance forever, it can help you during those first few years of owning a new car when you owe much more than the car’s value.

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