How Does Gap Insurance Work and Do You Need it?

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The dramatic plummet of your new car’s value as soon as you drive it off the dealer’s lot can put significant strain on your finances if your car is totaled.

That’s why when insuring a new car, you need to know the role gap insurance plays in protecting your investment.

If you’re entitled to an insurance payout for a totaled car, your car insurance company pays you the vehicle’s actual cash value (ACV). Unlike replacement value, actual cash value considers the replacement cost of the vehicle and then deducts depreciation. ACV will always be less than the cost to replace the car.

The amount your insurance company calculates as your car’s actual cash value can be thousands of dollars lower than what you still owe on your car lease or loan, especially within the car’s first few years of ownership. Since you’re responsible for paying the remainder of your lease or loan even when your car is totaled, you have to come up with the difference.

That is unless you have gap insurance.

What is gap insurance?

Gap insurance is an optional coverage that pays the difference between the amount a car insurance company pays for your totaled car and the amount you owe on your lease or loan. Without gap insurance, if you owe more on your loan than the actual cash value the insurance company will give you, you’ll be faced with coming up with the rest.

Here’s how gap insurance works:

You buy a new car worth $30,000 and you put down $2,000 pay other taxes and fees. Your loan is for $28,000.

A few months later, you total your vehicle in an accident. Your insurance company determines the actual cash value of the vehicle is $25,500. You have a $500 deductible, so your insurance claim payout ends up being $25,000 leaving you with an extra $3,000 to come up with to pay off your car loan. If you have gap insurance, this amount would be covered by your insurance company.

Do I need gap insurance?

You might need gap insurance if any of these situations apply:

• If your auto loan term is 60 months or more
• If you paid less than 20% down on your auto loan
• If you’re leasing a vehicle check your lease agreement first to see if it includes gap coverage.
• If you owe more on the vehicle than it is worth
• If you have financed a new vehicle

What is not covered by gap insurance?

Gap insurance should not be confused with coverage for anything above what your standard car insurance will cover. There are things gap insurance does not cover:

• Medical bills
• Property damage
• Damage to your car that isn’t a total loss
• Car problems, like mechanical issues that are not covered by our car insurance policy
• Past due lease or loan payments
• Excessive use penalties imposed by a lessor
• Non-refunded security deposits by the lessor
• Non-factory installed equipment
• Depreciation deducted by the primary insurer
• Extended warranties
• Carry-over balances from other loans or leases

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How much is gap insurance?   

Gap insurance is surprisingly affordable, at an average of less than $60 a year. But as with any insurance, the cost depends on where you buy it.

According to Insure.com’s Senior Consumer Analyst, Penny Gusner, “Insurance companies typically calculate gap coverage rates at 5% to 6% of your comprehensive and collision coverage costs.”

That means if your auto insurance policy premium is $600, gap insurance will typically add around $30 onto that.

Your cost will depend on where you get your gap insurance. Insurance companies use different factors in determining their rates and so their prices vary. In most cases, you can get a better deal on gap insurance through your insurance company than through a car dealership. In a report from the National Consumer Law Center, some dealerships marked up gap insurance costs by up to 300%.

How is loan or lease coverage different from gap coverage?

Similar to gap insurance is lease/loan coverage. Lease/loan coverage covers the gap between what you owe on your car and its actual cash value. However, the difference is that lease/loan coverage only provides a payout to a certain percentage of your vehicle’s value, typically around 25 percent. If your $30,000 vehicle has depreciated to $25,000, then loan/lease coverage covering up to 25 percent would pay up to $6,250.

Not all insurance companies offer gap insurance, but many will have lease/loan payoff coverage if they don’t have gap. While very similar to gap insurance, lease/loan payoff coverage only pages up to a certain percentage of the ACV of the totaled vehicle.

Where to buy gap insurance

There are a few different options for buying gap insurance, including buying from an insurance provider, a dealership or a third-party company. It is essential to know that the costs will vary significantly, depending on which you choose.

Which insurance companies offer gap insurance?

Most major car insurance companies offer gap insurance as an add-on to your standard car insurance policy if you carry collision and comprehensive coverage. Buying coverage through your insurer is often the cheapest option for gap insurance.

Insurance companies may refer to their gap coverage as loan/lease coverage, which may be slightly different. Here is a list of companies that offer gap insurance:

• AIG
• AAA
• Allstate
• Ameriprise
• American Family
• central mutual
• Chubb
• CSAA Insurance Group
• Esurance
• MetLife
• Mapfre
• Nationwide
• Plymouth Rock
• Progressive
• Safeco
• State Farm
• Travelers
• USAA

Can I buy gap insurance through a dealership?

You can also choose to purchase gap insurance through the car dealership where you’re purchasing the car. However, remember that you will pay an average of 300% more than through an insurance company.

Are there standalone policies for gap insurance?

There aren’t many companies that offer gap insurance as a standalone policy. Those who do often charge more than it will cost to add the coverage to your existing car insurance policy. However, if you’re interested in a standalone policy, the option is available through companies like GapDirect.

Other frequently asked gap insurance questions

What does gap insurance cover?

Gap insurance covers the difference between the actual cash value (ACV) of your vehicle and the outstanding balance on your loan or lease if your car is totaled or stolen. Some gap coverage will also pay your deductible.

How do I know if I have gap insurance?

Check with your car insurance agent to find out if you have a gap insurance add-on endorsement. If your vehicle is leased, check the lease terms or ask the lessor if gap insurance is included.

How long is gap insurance valid for?

If it is an add-on to your existing car insurance policy, your gap coverage will last as long as your standard policy does and will be renewed at the same time. If your policy is standalone, the coverage will be valid for as long as the policy is valid.

Is gap insurance worth it?

Gap insurance is worth it for people who owe more on the car than it is worth, made a low down-payment on the car loan, have a loan term longer than 60 months, have a car that depreciates faster than average or don’t have enough in savings to cover any coverage gaps.

At an average cost of $60 per year, gap insurance is an affordable way to bridge coverage gaps. It can provide peace of mind that you won’t have to wipe out your savings or incur high-interest debt to pay off your car loan if your car is stolen or totaled.

Penny Gusner

Contributor

 

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Penny is an expert on insurance procedures, rates, policies and claims. She has extensive knowledge of all major insurance lines -- auto, homeowners, life and health insurance. She has been answering consumers’ questions as an analyst for more than 15 years and has been featured in numerous major media outlets, including the Washington Post and Kiplinger’s.