If you’re planning to take advantage of end-of-year vehicle sales or are considering a new car purchase in the coming months, you’ll likely be offered a variety of add-ons before finalizing the deal. While experts advise buyers to avoid many of these—like extended warranties, rustproofing, and fabric protection—there’s one that deserves serious consideration: gap insurance.
With new-car prices averaging approximately $10,000 more than five years ago and financing terms stretching to six or even seven years to ease the financial burden, nearly one in four vehicle owners are currently “underwater” on their car loans, according to Edmunds.com. This means they owe more on their vehicle than its actual cash value for insurance purposes. If a financed vehicle is stolen or totaled in a wreck, the insurance company only reimburses the owner for the car’s actual cash value, not the purchase price. This can leave the owner owing a considerable sum to the lender, a situation exacerbated by minimal down payments and quicker-than-average depreciation.
Edmunds reports the average amount owed on upside-down loans has reached a record high of $6,458. This is where gap insurance comes in. This type of policy covers the difference between your vehicle’s worth and what you still owe on it if it’s stolen or totaled in an accident. The term “gap” stands for Guaranteed Auto Protection.
Gap insurance is a requirement in leasing contracts and is increasingly essential for those buying a vehicle, particularly more expensive models financed for extended periods. Additionally, it protects against the possibility of vehicles depreciating rapidly.
Experts recommend considering gap insurance if you:
- Are making less than a 20% down payment.
- Have rolled over a previous car loan balance into a subsequent purchase.
- Are financing a car, truck, or SUV for 60 months or longer, especially at today’s higher interest rates.
For example, consider a model that cost $40,000 when new but still has an outstanding loan balance of $32,000. If the owner is in an accident, and the vehicle is declared a total loss with an actual cash value of $26,000 and a $1,000 deductible, the insurance company would offer a settlement of only $25,000. Gap insurance, however, would cover the remaining $7,000 owed to the financing company.
Gap insurance can be purchased from a new-car dealership or added to an existing auto insurance policy, although availability varies by state and insurer. The cost is usually a few extra dollars per month if you add it to your insurance policy, or roughly $400 to $700 if purchased from a dealership. Some policies also cover the comprehensive and collision deductible, while some insurers bundle gap insurance as part of their new-car replacement coverage.
For those leasing a new vehicle, the leasing company or automaker’s financing division typically includes the cost in the agreement. Gap insurance is especially critical for lessees because a new-vehicle lease is essentially unbreakable. Whether the car is totaled or the lessee can no longer afford it due to job loss or divorce, they remain responsible for all scheduled payments. In these cases, the difference between what the lessee owes and the vehicle’s actual cash value can be substantial, especially if the automaker artificially inflated the vehicle’s end-of-lease value or offered significant cash rebates to boost sales.
Of course, gap insurance isn’t necessary if you own your car outright or if the vehicle’s value exceeds the amount owed due to a large down payment or a higher-than-expected resale value.
