Gap Insurance Can Be Worth It For Some People

by | Nov 24, 2020

Gap insurance is a type of insurance which is generally required when you finance or lease a vehicle. The purpose of the insurance is to cover anything a vehicle owner may owe on a car, to the financer, should it end up totaled. Essentially, a vehicle may not be worth what a car owner currently owes on the car. This discrepancy between what the car is appraised at and what the vehicle owner owes is not covered by insurance when the car is totaled, be it an accident or a natural disaster. Gap insurance makes up that difference between what is owed on a car loan and what the car is actually worth according to your insurance agency so that it may be replaced.

Gap Insurance Makes Sure You Don’t Owe Money On A Car That’s Totaled

At the end of the day, the purpose of gap insurance is to make sure you don’t end up owing your loan servicer more than what your car insurance company pays you after your car is totaled.

Carinsurance.com does a great job of giving us a slightly more in depth look at what it means:

If your car is totaled or stolen, gap insurance coverage will pay the difference between the actual cash value (ACV) of the vehicle and the current outstanding balance on your loan or lease. Sometimes it will also pay your regular insurance deductible.

Car owners often assume that if their car is totaled, it will be replaced at the amount they paid, or at least the amount they owe. This is not so. That is why many car insurance companies offer gap insurance (or loan/lease payoff insurance) as an optional coverage. You must also have comprehensive and collision insurance to buy gap coverage, but if you lease or finance your car, those are typically required.

If your insurer totals your vehicle by a covered peril, such as an accident, theft, fire, flood, tornado, vandalism, or hurricane, the insurer will pay you the actual cash value for your car, if you have comprehensive and collision insurance. This amount is often considerably less than the amount you still owe on your loan or the amount due for a lease payoff.

When the amount of your ACV payout is less than what you owe on your lease or loan, the loss from this financial shortfall is the “gap” you can be left owing. This is where gap coverage comes into play.

The reason gap insurance is so important is because of depreciation. Over time, due to wear and tear and other market factors, the value of your car decreases. For some models, this can be as much as 70% over the first 5 years of ownership.

However, if you take a car loan out to pay for your car, the amount that you owe is fixed. It won’t decrease just because the value of your car decreases.

It’s for this reason that cars are considered an expense, not an asset. Gap insurance is important for the same reason. Here’s an example.

Let’s say you buy a yellow Ferrari for $30,000 dollars new. You take out a 72-month loan for the entire purchase price of $30,000 and then drive away. Maybe we’re dreaming a little bit on the price, but still.

Our $30,000 dollar Ferrari.

1 years later, your Ferrari gets totaled. Let’s say you still owe $28,000 on your loan.

On average, most new cars lose about 20% of their value over the first year of ownership.

This means your $30,000 dollar Ferarri is only worth $24,000. In this case, since you owe $28,000 dollars but your Ferrari is worth only $24,000, you have what’s called negative equity. Negative equity just means you owe more on the car than it’s worth. In this case, you would have $4,000 in negative equity.

Going back to our example, when your $24,000 Ferrari is totaled, your car insurance will only pay you the $24,000 the Ferrari is worth, not the $28,000 you owe on your loan.

Without gap insurance, you will still owe the company that wrote your loan $4,000.

What Does Gap Insurance Cover?

Now that we have a better understanding of what gap insurance is, we can get into what it covers.

Gap insurance covers the difference between the market value of your car (which insurance will pay you if your car is totaled) and what you owe on your loan.

In other words, we can define what gap insurance covers as:

Gap Insurance Payout = (Amount Owed On Your Car Loan) – (Market Value Of Your Car)

Gap insurance does not cover specific parts. It covers the gap between what you owe on your car and the market value of it.

So, What Happens If You Have Gap Insurance And Your Car Is Totaled?

Let’s revisit our Ferrari from before to explain what happens. Let’s assume you didn’t have gap insurance and it was still totaled. Without gap insurance, you would still owe $4,000 on it, after the $24,000 insurance payout.

This means that you would have to continue making payments to the company that wrote your loan even though you no longer have the car. You can also pay the balance on your loan if you have the money. Otherwise, though, you are stuck with those monthly payments.

On the other hand, if you have gap insurance, your gap insurance policy will pay off the remaining $4,000 dollars you owe on your loan, which means no more monthly payments.

To be clear, gap insurance will not pay for a new car. It will only cover what you owe on your previous vehicle so you are free of any obligations and can start hunting for your next ride.

Do I Need Gap Insurance If I Have Full Coverage Insurance?

Regardless of what type of car insurance you have, Gap Insurance can still be useful.

This is because full coverage insurance will only pay you the market value for your car when it is totaled. The insurance company does not care about what you owe, it only cares about what your car is worth. As is such, even full coverage insurance will only pay you the actual cash value of your vehicle, even if this is less than your car loan.

Gap Insurance Is Useful If You Take Out A Large Loan

Now that we have a better idea of what gap insurance does, we can very clearly see that it’s useful for some people but not useful for others.

For example, you may want to buy gap insurance if:

  • You bought a new or used car and put down less than 20% of the purchase price;
  • You took out a car loan for more than 40-50% of your yearly income;
  • You roll over negative equity from an old car loan into the new loan;
  • You have a long loan, typically 5 years+;
  • You are leasing the car;
  • You have a luxury vehicle;
  • You have a vehicle that’s known to depreciate significantly;
  • You put more than the average 13.5k miles a year on your car;
  • You live in an area where severe accidents are common -cough- Florida -cough-;
  • You don’t have the excess cash to pay off any negative equity in a worst-case scenario;

On the other hand, you don’t need gap insurance if you haven’t taken a loan out on your car, or if your car is paid off. Even if you have negative equity, having cash on hand to pay it off means you don’t need gap insurance.

Keep in mind, if you lease a car or take out certain loans to buy said car, you may be required to have gap insurance.

If you aren’t required, gap insurance is worth it if you want to have the peace of mind that you aren’t going to end up paying for a totaled car that you no longer drive. It’s really that simple, and we will leave it up to you to decide if it makes sense for you.

If you do decide to buy gap insurance though, you generally will want to do so as quickly as possible.

The Longer You Wait To Get Gap Insurance The Harder It Is To Buy

At the end of the day, insurance companies are about profit first. They may claim otherwise, but everything is a numbers game. Gap insurance is no different.

Gap insurance for new cars that are financed or leased can be bought from several sources. These include your car dealer, your insurance company, your finance company, or a 3rd party company.

Generally, you need to be the original loan or leaseholder on the vehicle. You also need to purchase the policy shortly after you buy the car. Depending on the car, and the mileage driven you may not qualify for coverage the longer you wait.

The three most critical factors you should consider when deciding to add gap insurance to your vehicle includes the amount of money you put down, the length of your loan/lease term, and the type of vehicle. As the first two or three years is typically when you are most likely to owe more than what insurance will pay for a total loss or theft of your vehicle, these factors determine your need for gap insurance. They also make it important to act quickly.

Getting gap insurance is worth it for a new car, considering that the first 2-3 years is when you’ll likely have the most negative equity in your car.

As we mentioned before, you will have several options to buy your gap insurance including:

Buying It From Your Lender

In our opinion this is the worst of the 3 options. Lenders make their money by selling you add ons, including extended warranties and every additional cash grab they can handle. This is part of the reason we always advocate for consumers to buy their extended warranty plan from a direct provider. You can save a boatload of cash for the same protection.

Unless you are financing a vehicle and one of the loan terms is buying gap insurance through the lender directly, you should look elsewhere for coverage. Most often, your lender will mark up and sell coverage you could get directly from 3rd party.

Buying It From Your Car Insurance Company

Insurance companies will generally offer you a fair rate for gap insurance. Depending on how much you owe, as well as the vehicle you drive, you can expect to pay anywhere from about $12-28 dollars a month on average. It can be worth it to save thousands of dollars if you ever find yourself in a situation where your car is stolen or totaled. The last thing you need is the stress of paying back the loan after everything else.

The biggest difficulty in picking a car insurance company to handle your gap insurance is comparison shopping. Fortunately, our car insurance comparison platform can help you do it in about 5 minutes, instead of several hours. Just click here for more information.

Buying It From A 3rd Party

These can be hit or miss, but you absolutely can score a great deal with certain third-party companies that specialize in gap insurance. We recommend getting a couple of quotes from insurance companies first and then comparing the prices to any 3rd party companies you see.

How Long Does Gap Insurance Last?

Gap coverage will generally last between 1-3 years depending on your vehicle. Your individual policy may differ in the length of coverage. When you buy a plan, the duration of it will be spelled out in the contract so look there if you have any questions.

The thing is, you shouldn’t worry about how long your gap insurance will be in effect for because you should not plan to keep it forever.

Don’t Plan On Keeping Gap Insurance Forever: Have A Plan In Place To Drop It

As mentioned before, you may be required to have gap insurance by some lenders or if you lease a car. If that is the case, you won’t be able to drop your gap insurance until the car is paid off or you return the leased vehicle.

With those two exceptions aside, you can cancel your gap insurance at any time. Gap insurance fees and policies regarding cancelation may vary, so it is important that you read your policy before canceling just to make sure you won’t have any fees slapped on.

There are two ways to pay for gap insurance: upfront, or through monthly payments. When you do decide to cancel your gap insurance plan, you will be refunded accordingly.

If you paid upfront, you will receive a pro-rated refund for the amount of coverage you have remaining. If you paid monthly, you will be refunded the current month of payments.

As we mentioned before, gap insurance does not expire and it can last as long as the loan on your car generally lasts. Unless you are required to have gap insurance, you should make a plan to drop the coverage at some point.

There are 3 main cases where you should drop your gap insurance.

1: When Your Car Is No Longer New

You typically only need gap insurance for the first couple years that you own your car. Most of the depreciation takes place in the first 2 years, and the amount you owe will also go down as well. Once you no longer have negative equity in your car, you should drop your gap insurance coverage.

Wondering when that is? Start by looking at your loan statement to see how much you owe on your car. Make sure you include any negative equity from a previous vehicle you may have rolled over.

Once you know this amount, check your car’s actual cash value on the Kelley Blue Book site. If your car’s value is now close to the loan balance, you’re good to cancel. Remember, Gap Insurance is meant to pay the difference between the actual cash value and what you owe. If they are close, you are good to go!

2: You Sold Your Car Or Paid Off The Loan

Gap insurance does not transfer between vehicles. If you get rid of your car, your gap insurance will be canceled. If you paid up front for gap insurance when you bought the car, make sure you look into getting a refund for your unused coverage.

The same goes for if you’ve paid off your loan – if you don’t have a loan, there’s no outstanding balance to worry about if your car gets totaled!

3: You Think That You Are Overpaying For Protection

Gap Insurance should not cost more than $20-$30 dollars a year, according to the Insurance Information Institute. If you are paying more than this, you should drop the coverage and try to switch to something more affordable.

If you do decide to drop your coverage, congratulations! But if you choose to switch, or are still in the process of deciding which company to do with, we have one more helpful hint for you.

Who Offers The Best Gap Insurance?

Finding the right insurance provider is an exercise in patience. By now, you know all the big names in the industry thanks to their quirkly commercials and longstanding reputation for excellence.

However, when it comes time to price shop, all that goes out the window. Do you choose the Gecko or Flo?

Unfortunately, calling all of these companies can take hours just to get the best rate.

That’s where Protect My Car can help. Our insurance comparison tool, which we mentioned earlier helps you find the best rate with only a few clicks. Just click here to go to the page and fill out your information to get a personalized set of quotes from all of the best companies in the insurance industry that we partner with to get you the lowest rate.

PMC is now offering insurance!

On average, you can save between 15 and 25 percent and in several cases as much as  50 percent on your auto insurance. With the rising cost of insurance today, it’s important to have an agent who is experienced, knowledgeable, and dedicated to helping you find the most discounts and the best coverage available for all your insurance needs to protect your most valuable investments.

Our agents are dedicated and will continue to find you the best rate available at the time of your renewal. So if you are tired of paying high insurance rates or simply just can’t find the time to shop around, give us a call to speak to one of our licensed professional insurance agents to receive a free no obligation, no pressure quote.

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