Who Should Buy Gap Insurance?
If you were to ask an accountant what the definition of “depreciation” is, he or she would tell you that, simply put, depreciation is “the reduction of value of an asset over time.” If you have ever purchased a new car, though, you don’t need an accountant to explain depreciation to you. You knew what it was the moment you drove off of the dealer lot and your brand new “asset” immediately dropped ten percent in value.
Now that’s some real depreciation. Fortunately, you will probably never feel the sting of that instant drop. That is, unless you financed your vehicle and, fairly soon afterward, totaled it in an accident. That’s when you’ll be glad you purchased gap insurance. Or wished you had.
For those of you that don’t know, gap (aka guaranteed auto protection) insurance is a specialty insurance whose primary purpose is to cover the difference between your vehicle’s market value immediately before the accident (what your insurer is going to pay you for it) and the amount you still owe on the loan (if the loan amount is the higher of the two.) For example, let’s say that you purchase a new car for $30,000, financing $29,000 of the cost. The moment you drive it off of the lot, its value decreases (depreciates) by approximately ten percent. That means it is now worth $27,000. On the way home, you get into an accident and the car is totaled.
Your insurance company, for the purposes of paying you off, is going to value your car at the $27,000 figure, but you still owe $29,000 on your loan. That’s where gap insurance comes in.
1. Gap insurance makes up the difference when depreciation on your vehicle outpaces its fair market value.
This is the case described in our example.
If the amount your insurer pays you for your totaled vehicle (the fair market value) is less than what you owe your lender, then guess who has to make up the difference? (Hint: the answer is three letters long and contains “y,” “o” and “u.”) Gap insurance will pay off that difference (the $2,000 “gap” in our example) and possibly even the deductible you paid out-of-pocket for the accident.
2. Gap insurance can be beneficial in the cases of both purchased and leased vehicles.
If you have leased a car and you get into an accident early in the lease period that totals it, you could very well face the same financial “gap” problem as if you had purchased it with a loan. Therefore, if you are leasing a vehicle, you should strongly consider purchasing a gap policy. Check the language of your lease agreement carefully, though. Gap insurance is often written into leases, making your separate purchase of it unnecessary.
3. Gap insurance is particularly helpful to those who make low down payments.
If you cannot afford to make a high down-payment on your vehicle, you should seriously consider getting gap insurance. A low down-payment means that you are financing a higher percentage of your car’s full price.
That, in turn, means a bigger “gap” when your car first begins to depreciate. A bigger gap means a bigger loss for you if your car is totaled early on in your loan or lease. Unless you have gap insurance to save the day.
4. It’s also particularly helpful for those with long lease periods.
Generally, long lease periods (five years or more) should be avoided if possible. The longer the lease, the more you will end up paying for your vehicle in total. A long lease also means that it will be longer (often much longer) before the gap between what you owe and what your car is currently worth disappears. In such cases, gap insurance can protect borrowers for many years.
Finally, here’s a big tip when it comes to purchasing gap insurance: shop around. As with regular auto insurance, the cost of gap insurance can vary significantly from one insurer to the next.
Also, beware of purchasing a gap policy from your auto dealer. Their policies tend to be the most expensive. Remember, the more quotes you get, the more likely it is that you will save money.