As purchases go, buying a new car is actually a pretty poor investment. This is because most vehicles have an exorbitant rate of depreciation. In fact, your new car or truck starts losing value as soon as you drive it off the lot!
According to Kelly Blue Book, most vehicles lose approximately 20 percent of their original value after the first year. Additionally, The Black Book, which tracks pricing for used vehicles, shows a consistent depreciation rates ranging between 10 to 17 percent annually since 2012. This means that, at best, your new car or truck will lose about 60 percent of its original value after just five years. And that’s the optimal scenario. Black Book’s April 2018 Fitch Ratings Vehicle Depreciation Report actually predicts depreciation will land on the higher end of the spectrum; car owners can expect their used vehicles age two to six to lose 17 percent of their value in 2018.
The depreciation of a vehicle is dependent upon a number of important factors, including age, mileage, supply, auction prices, new model incentives, and location. It also varies based on the make and model. The end result, however, is always a steady loss of value over time.
Depreciation poses a significant problem for car buyers who can’t pay the full price of a vehicle up front. While the car or truck begins losing value immediately, the financed loan amount remains the same. If something happens to the vehicle after its purchase, the payout is likely to be considerably below the amount still owed on the loan. This frequently results in the loss of the car, no means to acquire a new one, and a large bill that still needs to be paid.
What is Gap Insurance?
The best way to protect yourself against this type of situation is by purchasing gap (guaranteed auto protection) insurance. Gap insurance, which is sometimes referred to as loan or lease gap coverage, is an optional insurance coverage designed to help drivers pay off their auto loan. Specifically, it’s meant to pay for the “gap” between your remaining loan amount and the actual cash value (ACV) of your vehicle after depreciation.
You can often purchase gap insurance when buying a new vehicle from a dealership. While this may be a convenient option, it usually isn’t the cheapest. Most auto insurance companies offer gap insurance as an add-on or include it in discounted coverage plans. It’s not uncommon to find insurance policies that include collision coverage, comprehensive coverage, and gap insurance at a significantly discounted rate.
Not only do many insurance companies offer gap insurance coverage at a lower rate, but they also allow drivers to cancel their policy at any time. This is important, as the gap between your auto loan amount and your vehicle’s ACV will decrease a lot after the sixth year of ownership, making the coverage far less helpful. If you purchase gap insurance from a dealership, however, it’s impossible to discontinue your enrollment in their gap insurance program. Ultimately, you’ll be forced to continue paying for a service that you really no longer need.
How Gap Insurance Works
As an example, imagine that you’ve just purchased a new vehicle that required financing. You drive that car off the lot, happy beyond belief with your purchase, and make your way home. Six months later, you’re driving to the grocery store to pick up a few things and out of nowhere another driver slams into your vehicle. No one involved is injured, but your brand new vehicle is completely out of commission.
If You Don’t Have Gap Insurance
The accident is covered and you’re not at fault, but your vehicle is damaged beyond repair. Your insurance company quickly begins working to determine your car or truck’s ACV. They agree to pay $27,000, but you still owe $30,000 on your auto loan. Now, you’re out a vehicle and are still responsible for paying the $3000 difference between the ACV and your auto loan.
If You Have Gap Insurance
The accident is covered and you’re not at fault, but your vehicle is damaged beyond repair. Your insurance company quickly begins working to determine your car or truck’s ACV. While they determine that the ACV of your vehicle is $27,000, but your gap insurance policy kicks in. Instead of paying you the ACV, they agree to pay the full $30,000 that’s left of your auto loan. You’re out a vehicle, but it won’t be too difficult to receive financing approval to purchase a new one.
It’s important to remember, however, that some insurance providers still require that the policy deductible is met prior to the gap insurance payout. If the gap between your auto loan and the ACV of your vehicle is $3,000 and your insurance company requires a $500 deductible, then your total gap insurance payout will be $2,500. To avoid any unnecessary confusion, make sure you take time to read through your specific gap insurance policy as it relates to deductibles.
What Gap Insurance Covers
While the concept of gap insurance is relatively simple, the specifics regarding most coverage plans can be a little tricky. Many drivers are often left with questions, the chief among them being, “What exactly does it cover?” Generally speaking, this auto insurance add-on only covers damage to your vehicle that results in a total loss. That means you should be covered for the following:
- Stolen and unrecovered vehicles
- Total vehicle losses
- Negative equity
It’s important to realize that most insurance companies have their own gap insurance guidelines. For example, an insurer’s gap insurance may cover a stolen vehicle, but only after a 30 day waiting period. A different insurance company, on the other hand, may have a shorter or longer waiting period after the claim is filed. For specifics regarding your coverage, you should always research the policy online or contact your insurance provider.
What Gap Insurance Doesn’t Cover
As an add-on policy, gap insurance only covers the loss of your vehicle. That’s why it’s important to have other forms of auto insurance as well. To avoid confusion, here are a number of expenses that are not covered by gap insurance policies:
- Past due loan or lease payments
- Repossessed vehicles
- Property damage
- Bodily injuries resulting from the accident
- Rental cars
- Carry-over balances on previous auto loans
- Extended car loan warranties
- Lease penalties for excess mileage
- Equipment that wasn’t factory-installed
- Medical expenses
- Lost wages
- Deductible costs
- Mechanical repairs
- Funeral expenses
- New car replacement
- Lease and loan security deposits
An important factor to consider is that gap insurance does not help you replace your vehicle after it’s designated a total loss. In many cases, the gap insurance payout is sent directly from your insurance company to your auto lender. If you’re concerned about replacing your vehicle after an accident, new car replacement coverage is more appropriate. Depending on your preferred insurance company, you may be able to find a coverage plan that includes both gap coverage and new car replacement coverage. Bundling services usually results in a discount, so it may be worth looking into when choosing coverage for your new or leased vehicle.
Who Needs It?
Gap insurance is best suited for individuals purchasing a brand-new car. It’s common knowledge that many financing lenders require buyers to have both collision and comprehensive coverage until the vehicle is completely paid off. In some cases, these companies require drivers to acquire gap insurance as well.
Additionally, individuals who prefer to lease vehicles instead of buying them are often required to have gap insurance. Many leased vehicle agreements actually include gap insurance in the total cost of the lease. If it is not included, however, the driver is usually expected to provide proof of gap insurance coverage within a certain period of time.
When purchasing or leasing a new vehicle, you should always check your coverage paperwork thoroughly to determine whether gap insurance is or is not included.
Other circumstances during which purchasing gap insurance is a good idea are when you:
- Buy a vehicle of significant value
- Put less than 20 percent down on your initial car purchase
- Agree to financing over a 60 month period
- Buy a vehicle make and model that loses value faster than average
- Roll over negative equity from a previous auto loan into your new one
- Are part of a single-car family that depends on regular transportation
- Don’t have enough cash savings to cover the ACV-loan gap if your vehicle is stolen or totaled
- Drive more than 15,000 miles on average per year
An important determining factor should be mileage driven, as added miles will depreciate the value of a vehicle very quickly. According to the Department of Transportation, average drivers put 13,476 miles on their vehicle each year. If you know you drive more than this, gap insurance can be very beneficial.
Is It Worth It?
While gap insurance is perfect for certain situations, it isn’t always necessary. This is especially true for individuals interested in purchasing used vehicles that are at least six years old. Not only are auto loans usually lower for older vehicles, but the gap between the ACV is less.
Circumstances during which purchasing gap insurance is unnecessary are when you:
- Already know that the worth of your vehicle exceeds your auto loan
- Have enough money to continue making payments on the auto loan even if the vehicle is declared a total loss
- Won’t need to replace your vehicle after being damaged beyond repair
- Will be paying on your auto loan for a short time (less than 12 months)
The best way to determine whether gap insurance is worth the expense is to carefully compare the amount owed on your auto loan to your vehicle’s ACV. You can usually obtain an estimated value of your car or truck by utilizing sites like Kelley Blue Book. If you owe more on your loan than your vehicle is worth, gap insurance is usually beneficial.
Gap Insurance Providers
While you can purchase gap insurance from an auto dealership, financing institution, or leasing agency, many car insurance companies offer coverage as well. Every policy will be different, with varying regulations and costs. In order to find a policy that suits your needs, vehicle, and budget best, take time to research all of the options thoroughly.
The following insurance companies offer some form of gap insurance or loan/lease payoff coverage:
- American Family
- Nationwide Insurance
- Allstate
- Farmers
- Trusted Choice
- Progressive
- Esurance
- Travelers
If you’re financing your vehicle through the insurer’s bank, you may also qualify for gap insurance coverage from organizations like the American Automobile Association, State Farm, and USAA. You can also purchase gap insurance from a stand-alone gap insurance provider. Many of these are online and require a one-time payment made up front. Examples include Gap Direct and Gap Insurance Quotes.