Knowing when you have enough coverage for your vehicle can be difficult. While you don’t want to overpay for insurance you’ll never use, you also don’t want to be stuck with limited coverage. In the latter case, you could find yourself covering a big, sudden car bill out of pocket.
GAP insurance is a type of optional coverage that can help those who own newer cars that haven’t been paid off yet. Knowing how GAP insurance works and when to purchase it could help you make a decision and potentially save you thousands of dollars if the worst happens to your vehicle. Read on to learn more about GAP insurance and whether it could benefit you with your car.
Understanding Car Depreciation
When you finance a vehicle, the lender wants assurance that they would not take a loss if something were to happen to the vehicle, such as if it were stolen or totaled in an accident. Most lenders require you to keep collision or comprehensive coverage. This type of insurance covers the value of the vehicle, so the lender doesn’t lose money on their asset.
The problem is that most comprehensive insurance policies only pay out the value of the vehicle at the time of the accident. Many people are not aware that a new vehicle depreciates in value as soon as you drive it off the lot. If you buy a new vehicle and return it the next day, you might find that it is now considered a used car, and they will refund you less for it.
New cars depreciate faster than used ones in the beginning. The rate of depreciation depends on how many miles you drive, the fuel economy of the vehicle, its condition and reputation, and how easy it will be to resell it. Popular cars depreciate more slowly than ones that are not as desirable. A new car can depreciate as much as 9%–11% of its value the first minute you drive it off the lot. After a year, the value drops another 20%–40% from the price you paid when you bought it.
Depreciation for new cars is the most dramatic because they lose value quickly when compared to their original price, but used cars continue to be affected by depreciation. That is one of the reasons why many buyers choose to purchase a car that is a few years old. It has already experienced the initial rapid depreciation and offers a better value.
However, your new-to-you car continues to depreciate every year. Depreciation rates on used cars are highly variable. There are handy online calculators that can help you estimate the current and future value of your used car.
Why Does Depreciation Matter?
The first time depreciation matters is when you are purchasing a used vehicle. If you are financing the vehicle, your lender will make sure the car has not depreciated so much that it would be worth less than the loan if you were to default, and they had to sell it to recover their losses.
The second time when depreciation is important is when you decide to use your vehicle as a trade-in. Depreciation affects the price the dealer will offer you.
The third time when depreciation makes a difference is when you have an insurance claim, and the insurance company has to decide how much your payout should be. Even if you are no longer able to drive the vehicle, you are still responsible for the full amount of the loan. Insurance companies pay only for the current replacement cost of the vehicle — not its value when you purchased it.
This means there will be a difference between what the insurance pays and what you still owe your lender. Without GAP insurance, you will be responsible for paying the difference out of your pocket. On a newer used vehicle, the difference can be hefty.
What Does It Mean When a Car Is Totaled?
If you get into an accident, you might be surprised that the insurance company will not pay for the repairs, even if they are relatively minor, and the car is still drivable. When a car is totaled by an insurance company, it means that the cost of the repairs is greater than the current depreciated value of the vehicle. In short, they will not pay more for the repairs than what the car is worth.
State insurance laws vary on when a car can be declared totaled. This has to do with the cost of repairs, not the actual damage and its ability to be fixed. If you have GAP insurance, it will help cover any difference between what the insurance company will pay you to replace a totaled car and what you owe on the bank loan.
Let’s say your used car was valued at $18,000. Three years later, you are in an accident in which it is totaled. At that time, you still owe $16,000, but the car’s depreciated value is only $14,000. You would still owe the bank $2,000 to pay off the loan. If you had GAP insurance, it would pay the $2,000 difference.
Keep in mind that in this scenario, you no longer have a drivable car and need to buy a replacement. Some insurance carriers offer GAP insurance and vehicle insurance replacement insurance as a single package or as separate add-ons. Now that you know what GAP insurance is and why you should consider it when buying a used vehicle, let’s see how you get it.
How to Purchase GAP Insurance
GAP insurance will usually be offered to you at the time of purchase. It is often offered at the dealership, but you can also purchase it through many insurance carriers, often for less. In some cases, you might be able to purchase GAP insurance from your carrier even after you have closed on the loan and taken possession of the car. Not all carriers offer this option.
One thing to keep in mind is that GAP insurance usually applies only to the purchase of new vehicles, but some used dealerships have access to GAP insurance, too. You should consider GAP insurance for your used car in the following situations:
- When you made a low down payment or paid zero down
- If the length of the loan is over 60 months
- When you are purchasing a newer used vehicle
- If you are leasing
Is GAP insurance worth it? The answer to this question depends on several factors, including the age and value of your vehicle. If you meet any of the above conditions, GAP insurance is usually suggested. The question you need to ask yourself is how you would cover the difference if you had to bridge the gap between the value of your car and the amount you still owe on the loan.
Typically, GAP insurance is relatively inexpensive when compared to the peace of mind it gives you if something unfortunate were to happen.
