Most people who buy a new car need financing to pay for their purchase. This being the case, most car dealers will want to sell you gap insurance (guaranteed auto protection). Gap insurance is an optional auto insurance coverage. It can be very useful for some drivers. Essentially, it covers the gap between your vehicle’s actual worth and how much you owe on the loan for that vehicle. This is important if there is an accident and the car is declared a total loss. The gap insurance protects you financially. It covers the difference between the actual cash value of the car and what you still owe on the loan. This could in some instances be more than what the car is worth.
Car dealerships will usually offer you gap coverage for new and relatively new cars. Leases will also often include gap insurance.
Why would you need gap insurance?
Gap insurance protects you from the fact that a new car depreciates by a significant amount from the moment you drive off the car lot. This can leave you with a car that is now worth less than what you still owe on the loan to pay for it.
Long car loan
If you choose to take a long car loan, such as 60 months or more, the depreciation is even more of a factor. The longer the loan, the more time it takes to reach the point when the loan and the car’s value are equal. So for several years, your vehicle could be worth less than what you owe on the loan.
Small down payment
That gap could be even wider if you make only a small down payment on your new car. In addition, part of your car loan may have covered costs that are not even a part of the car’s value (taxes, for example). This can extend the value gap even further.
Regular auto coverage
You have no control over how an insurance company will decide the value of your car if it is written off as a total loss. This can result in a situation where the compensation provided by your insurer may not be enough to pay off the entire car loan. This gap could be particularly large if you don’t have replacement value coverage as part of your regular car coverage. Insurance policies base the value of your vehicle on the actual cash value. This could be quite different from what you paid for it.
Gap insurance only comes into play if your vehicle is a total loss or is stolen and written off. If your insurance company pays you less than your car loan balance, the gap insurance will pay the difference.
Who offers gap insurance?
Gap insurance is offered by car dealerships and lenders. It is an insurance policy separate from your regular auto insurance coverage. It can be bought from the dealership or finance company when you are getting a loan or lease for a new vehicle. The premium can be included within your car loan.
When should gap insurance be cancelled?
Cancel your gap insurance once you (a) owe less on your loan than the car is worth and/or (b) pay off your car loan.
When purchasing a new car, gap insurance can give you peace of mind. It reduces the financial risk should your car be worth less than your loan at the time of an accident.