Gap insurance: What is it? And is it for you?

Few “big-ticket” purchases lose their value faster than vehicles. Depreciation, the difference between what you paid for the vehicle and what it’s currently worth, is an unfortunate reality for car buyers. In fact, the average car loses 20% of its value in the first year of ownership and retains just 40% of its purchase price after five years!

woman drives her new car off the dealership lot

This quick rate of depreciation can create tremendous headaches for those whose vehicles are lost through no fault of their own, such as in a crash. Let’s run through a scenario to illustrate the problem: This year, you purchase your dream car for $50,000. You didn’t have much money for a down payment, so you financed the purchase by getting a loan from your credit union that calls for the loan to be paid off in 6 years.

Two years later, your car is totaled after another driver disregarded a stoplight and smashed into you. After accounting for the year, make, model, mileage and condition of your vehicle, the at-fault insurance company offers just $35,000 as the current market value for your car. Meanwhile, the credit union says that you owe over $41,000 on the auto loan. Thus, you still owe over $6,000 for a car that you don’t even own anymore, due to an accident that you did not cause!

What is gap insurance?

This extremely unfair storyline plays out far too often in real life. How can car buyers protect themselves from being “upside-down” when their cars lose value as soon as they’re driven off the dealership lot? The answer is gap insurance. Gap, which stands for “Guaranteed Asset Protection,” is an additional insurance policy that covers the difference between what a vehicle is currently worth, and the amount you actually owe on it in the event of an accident.

stressed out man and woman at the scene of a car accident

Gap insurance is typically offered by the car dealership when you’re in the process of purchasing a vehicle. If you add this coverage at the time of purchase, the cost of the coverage is usually added into the cost of the vehicle. However, you can also buy gap from your own insurance company and add the cost to your pre-existing premium. Your loan provider may also offer gap coverage.

When does it make sense to purchase gap insurance?

If you cannot afford to make a hefty down payment to close the gap between what you owe and the car’s actual market value, you should strongly consider gap insurance. If you’re leasing a car because you like paying lower monthly payments (leading to negative equity), you’d better protect yourself and buy gap insurance. If you put a large number of miles (over 15,000 per year) on your vehicle, gap insurance is vital because excessive miles accelerate the rate of depreciation.

What if you sell your car before paying off the loan, and paid for gap insurance up front?

In this event, you are often entitled to a refund for the portion of the insurance you didn’t use.

If you did not purchase gap insurance and wind up in the scenario that was described earlier, the options are far from ideal. The solution most employed by those in a deficit is to roll their remaining loan balance into a new loan when they purchase a replacement vehicle. This causes unlucky car buyers to dig out of an even deeper hole of negative equity and makes the purchase of gap insurance essential to protect themselves in the event that another car accident occurs.

If you have been injured in an auto accident through no fault of your own, you may be entitled to compensation. Call Allen & Allen today for a free consultation at 866-388-1307.