What Is Gap Insurance and Do You Really Need It?

Key Takeaway:

Gap insurance covers the difference between your car's actual value and your remaining loan amount if your car is totaled. It is highly recommended if you made a small down payment.

Buying a new car is very exciting. You sign the papers and drive off the lot with a big smile. But did you know your new car loses value the moment you drive it away? This sudden drop in value can create a big financial problem if you get into an accident.

This is where understanding practical personal finance tips can save you from a huge bill. Many drivers do not know about the gap between their loan balance and the car's real value. We will look at what is gap insurance and see if it makes sense for your budget.

What Is Gap Insurance and How Does It Work?

Gap insurance is a special type of car coverage. The word gap stands for Guaranteed Asset Protection. It helps you pay off your car loan if your vehicle is stolen or completely destroyed in an accident.

Standard car insurance only pays for the current market value of your car. Cars lose value very fast during the first few years. If your car is totaled, your regular policy might not pay enough to cover your remaining loan. Gap insurance steps in to pay that leftover balance.

A Real Example of Gap Insurance in Action

Let us look at a simple example to show how this works. Imagine you bought a new SUV for thirty thousand dollars. You took out a loan for the whole amount with no money down.

One week later, you get into a bad crash. No one is hurt, but your SUV is a total loss. Your insurance company says the SUV is now only worth twenty-four thousand dollars because of depreciation.

Your insurance company sends a check for twenty-four thousand dollars to your lender. But you still owe thirty thousand dollars on the loan. If you have gap insurance, that policy pays the six thousand dollar difference for you.

Who Actually Needs to Buy Gap Insurance?

Not every driver needs to buy this extra coverage. If you made a big down payment, you are likely safe. Your loan balance is probably lower than the car's value from day one.

However, some buyers should definitely get it. You should consider it if you leased your car. You also need it if your loan is longer than sixty months.

It is also smart to get if you rolled debt from an old car loan into your new one. If you want to avoid these traps, read our guide on buying a used car to make better buying choices.

Where Can You Buy This Insurance?

You have a few choices when it comes to buying this coverage. The most common place is the car dealership. They will offer it to you when you sign your loan papers. However, this is usually the most expensive choice.

A better choice is to call your regular car insurance company. Many major insurers sell this coverage for just a few dollars a month. It is usually much cheaper than buying it from the dealer.

When Can You Cancel Your Policy?

You do not need to keep this coverage forever. You only need it while you owe more than the car is worth. Once your loan balance is lower than the car's value, you can drop the coverage.

Keep track of your loan statements and check your car's value online. When your loan balance drops below that number, call your insurer. Tell them you want to cancel the gap coverage to save money.

Frequently Asked Questions