Matthew Oliver
One of the worst things that could happen actually happens: your car is totaled in an accident, but what your insurance company pays you isn’t enough to cover the remaining balance on your loan. Now, you’re faced with some hefty expenses to replace your vehicle.
That’s where gap insurance steps in. This coverage helps pay for the difference between your car’s actual value and what you still owe. However, while it sounds like a smart choice, it’s not always the best fit for everyone. To make the right decision, it’s important to weigh the benefits and potential drawbacks of gap insurance against your financial situation.
Let’s take a look at whether this coverage is right for you.
What are the Benefits of Gap Insurance?
When deciding if gap insurance is the right fit, it’s important to consider what it brings to the table. From helping protect against depreciation to covering losses from theft or accidents, this coverage offers unique benefits. In some cases, it’s even required for leased vehicles.
Let’s break it down further.
Protection Against Depreciation
New cars lose value quickly—about 20% in the first year and 15% in the years thereafter—and gap insurance helps cover the difference between an insurance payout and the remaining loan balance. For example, if a car originally worth $35,000 depreciates to $30,000 within a year and is totaled, gap insurance can help cover the $5,000 shortfall, reducing the financial burden.
Financial Safeguard in Case of Theft or Total Loss
Gap insurance helps borrowers meet their loan obligations if a car is stolen or irreparably damaged. Without it, you could be left making payments on a car you no longer have. This coverage helps avoid financial strain in these unexpected situations, offering peace of mind during challenging times.
Beneficial for Low Down Payments and Long-Term Loans
When financing a car with a small down payment or choosing an extended loan term, the loan balance may exceed the car’s value for a long period. Gap insurance helps address negative equity, offering a financial safety net for buyers in such scenarios.
Mandatory in Certain Lease Agreements
Leasing companies often require gap insurance to protect their financial stake in the vehicle. This helps lessees avoid paying out large sums after a total loss incident, preventing potential financial stress and ensuring compliance with lease terms.
Affordable Addition to Insurance Policies
Gap insurance can be obtained in two convenient ways. You can add it to your existing auto insurance policy, or it can be included as a flat fee in the purchase price of your vehicle through your lender or dealer. The cost typically falls between $500 and $700, making it valuable coverage at a manageable price point.
But is Gap Insurance Really Worth It? Know the Risks
You may have read that last section and thought that $500 to $700 is pretty reasonable to help protect you in the event you need it. And while gap insurance can be useful for many car buyers, it’s not always necessary. Here are some of the risks to be aware of before you sign on the dotted line.
Not Necessary for All Vehicles
Gap insurance may not be needed if your vehicle has a low depreciation rate or if you made a substantial down payment. In cases where your loan balance is equal to or less than the car’s value, the coverage may not provide meaningful benefits, making it an unnecessary expense.
Limited Coverage Scope
Gap insurance applies only in total loss situations, such as theft or irreparable damage. It doesn’t cover mechanical breakdowns, standard accidents, or medical costs. Additionally, some policies exclude deductibles, meaning you may still face out-of-pocket expenses even with coverage in place.
Potential for Redundant Coverage
Certain auto loans or lease agreements already include gap insurance. If this coverage is part of your contract, buying a separate policy may be redundant. Reviewing your current loan or lease agreement can help you avoid paying for coverage you may already have.
Cost Variations Based on Purchase Source
The cost of gap insurance can vary significantly depending on where it’s purchased. Policies offered by dealerships are often more expensive than those available through insurance companies. Rolling the cost into your car loan may also increase your interest payments over time, making it a less economical option.
Diminishing Need Over Time
As you pay down your loan and vehicle depreciation levels off, the gap between what you owe and the car’s value diminishes. This can reduce the necessity of gap insurance. Periodically comparing your loan balance to the car’s market value can help determine if maintaining the coverage is still worth it.
Your Decision: Is Gap Insurance Right For You?
Gap insurance can be a helpful tool for some car buyers, but it’s not the right fit for everyone. Understanding its benefits and risks can guide you in making the best decision for your situation. For more car-buying tips and insights, be sure to check out the RateWorks blog!
