A lot of car buyers do not know that if a peril such as theft or an accident made their car to be declared a total loss, their insurer is not obligated to compensate them in full. That is, unless, they have new-car replacement coverage, also known as GAP insurance. Now, if you had purchased the car on loan, and such a calamity happens, you might end up owing more than your car is worth. So, how do you safeguard yourself against this risk? The simple answer is GAP insurance. The following article is a guide to everything you need to know about this insurance.
What is Gap insurance?
An acronym for ‘Guaranteed Asset Protection’, gap insurance is a type of auto insurance that you purchase to protect you from losses that are bound to arise if the amount of compensation you are receiving from your insurer for a total loss doesn’t fully cover the amount you owe on the car’s financing or lease agreement.
As such, your creditor or lien holder might require that you incorporate gap insurance into your car insurance policy. However, even if it is not a mandatory requirement, getting this policy will help you salvage as much as you can following a loss. Gap insurance does not cost a lot. Generally, to know what it would cost you, take what you are paying for comprehensive insurance and just add another 5 percent.
How Does It Work?
In case you didn’t know, the moment the car dealer hands you the keys, and you drive off, the vehicle’s value begins to depreciate. Thus, if you are using an auto loan to lease or finance the car, the vehicle’s worth will be less than the principal balance on your loan or your combined lease payments.
Therefore, if the car was to get totaled in an accident or some other form of peril, such as getting stolen and not getting recovered, your insurer is more than likely only going to pay for the car’s actual cash value. The actual cash value is the vehicle’s current value after accounting for depreciation. And because the actual cash value us bound to be less than what you owe on the loan or lease, you will continue to owe money to these parties for a vehicle you no longer have. This is what is referred to as negative equity.
To put this situation into perspective, consider the following: You purchase a new truck for $40,000, including fees and taxes. A year down the line, the truck gets stolen, and you are unable to find it. On filing a claim with your insurer, you discover that your truck is valued at $32,000, its current value after depreciation.
Meanwhile, after making a year’s worth of payments, you owe your creditor $35,000. This implies that you have $3,000 gap that you need to pay out of your own pocket. If you have gap insurance in your car insurance, your insurer will pay both the $32k and $3k.
Who Does Gap Insurance Help?
If your car is depreciating at a rate that is slower than that at which your payments are reducing the loan, then gap insurance might not be that necessary. Nevertheless, that is rarely the case.
The following are some of the most important reasons why you need a gap coverage:
- You Owe More than Your Car is Worth – This is usually the case if either the car is still new, or your payments cannot outstrip the rate of depreciation.
- You Made a Low Down Payment On Your Loan – If your down payment was less than 20% of the vehicle’s value, and the loan has an estimated term of over four years, it is likely that you will always owe more on the car than its present value, for the first two years at least.
- Your Financing is Long-Term – The nature of long-term financing is that it allows you to make smaller payments as they are spread out over a longer period. And even though this allows you to purchase the vehicle sooner, you will perpetually owe more than the car’s value as your small payments will not be able to nullify the effects of depreciation.
- You Are Not in a Position to Pay Out of Your Pocket – If your payment plans have ensured that you will always owe more than the car’s value, in the event of a disaster, such as a car gets totaled or stolen, you will pay for that gap out of your pocket. If you do not have those kinds of funds, then a gap coverage will safeguard you against it.
- You Average More than 15,000 Miles Every Year – Driving directly affects the rate of depreciation. If you drive more, the car depreciates faster than if you drove less.
- The Type of Vehicle – Some cars just depreciate faster than others, especially luxury vehicles. This is because their value often depends on their newness. Thus, look into the depreciation rate of a car when considering to purchase one.
- The Susceptibility of Your Vehicle to Theft – If you own a popular car, a gap coverage is almost necessary. Even though your comprehensive insurance might cover theft, and you already have it for your car, getting gap insurance is only wise to ensure that the gap caused by depreciation is covered, considering your vehicle is highly susceptible to theft.
What Gap Insurance Covers
Gap insurance is essentially an extension of your property damage insurance and falls under your general car insurance coverage. It is used to enhance collision and comprehensive insurance. In collision insurance, your car is covered against damage arising from an accident with another vehicle, while comprehensive insurance offers coverage against perils such as natural disasters or theft. However, in case of a total loss, both coverages will typically pay only for the actual present value of the car. Thus, gap insurance essentially offers coverage for depreciation.
What It Does Not Cover
The important thing to note here is that a gap coverage only insures events surrounding damage or loss of your vehicle. Thus, it will not cover things such as liability to others or medical expenses.
These are covered in your comprehensive insurance policy. Nevertheless, let us look at what your gap insurance does not cover in detail.
- Medical Bills – If you get into an accident and you or someone else gets injured, your gap insurance will not help pay for the subsequent bills. These, instead, are catered for by the body liability coverage. The liability coverage also pays for funeral expenses for any person that dies following an accident with your car, and you are at fault. A personal injury protection coverage pays for you and your passengers’ medical bills if you get into an accident where nobody is at fault.
- Damage to Another Person’s Property – This falls under your property liability insurance, even though it is your vehicle that caused damage to their property, and got totaled in the process.
- Repairs – Gap insurance will not pay for any mechanical repairs that you undertake following an accident. It only offers you coverage for how much you owe on a loan after your vehicle is lost all completely totaled.
- Comprehensive and Collision Deductibles – Comp and collision policies tend to collect deductibles, which are the sums you pay out of your pocket before the insurance company can pay you the rest. And even though gap insurance itself does not have a deductible, it also won’t pay for any deductibles owed to the comprehensive and collision coverages.
- If Your Car is not Completely Totaled or Lost – Here is where things get interesting; even though gap essentially offers coverage for depreciation, if you were to get into a bad accident, but your insurer is able to salvage and restore your car, your gap coverage will not come into play even though the accident will have depreciated your car further. Gap only comes into play if your car is completely totaled or lost.
The Cost of Gap Insurance
You are probably going to first hear about gap insurance from your car dealer during the final stages of the purchase. Nevertheless, do not fall into the trap of getting that coverage from them without looking elsewhere. Here’s the thing, car dealerships will often charge two to three times on gap insurance than what you would get from an auto insurer. Thus, it is important that you first check with your auto insurer to see how much they charge. Nevertheless, the typical rates of auto insurers are around $20 a year while a car dealership could charge you a flat fee of $400 to $600 for gap insurance.
Gap insurance is essential for anyone who purchases their car on loan. More often than not, your vehicle will depreciate faster than you can pay for it. Hence, in the event of a total loss, you will not only have lost the car, but you will still be owing additional money to your creditor or lienholder. An insurance policy for gap coverage will safeguard you against that kind of situation.