Is Auto Gap Insurance Really Necessary?

If you’re buying a new car, there’s a type of car insurance that you may be unfamiliar with, but that might be completely necessary. It’s called “auto gap insurance” — so named because it covers the difference, or gap, between the true value of the car and the loan outstanding against it when the loan exceeds that value. More people have a need for this coverage than are even aware of it. Too bad you can’t get this kind of insurance for investment losses!

The coverage won’t come into play in the event of common accidents and damage, but it will be a major factor in the event the car is either stolen or totaled. An ordinary auto insurance policy will cover only up to the true value of the vehicle at the time of the theft or totaling accident, which will force you to cover out-of-pocket any portion of the loan balance that exceeds the insurance payout. If you don’t have the money, you might find yourself without transportation. How is that going to impact your ability to hold your job? It might have huge repercussions.

When do you need gap insurance?

Generally, you’ll need gap insurance any time you owe more on your car than it’s worth. Here are some of the major situations in which this can occur:

• When you lease a car. It’s often required as part of the lease agreement, and it’s more important than on purchases because you have no equity in the vehicle.
• When you’re “upside down” on your car loan. If you owed more on your last car than it was worth, the dealer may have accepted it as a trade-in, but probably rolled the shortfall over to the new car loan. Even if you made a cash down payment on the new car, you may still be upside down on the new one.
• When you expect to put an excessive amount of miles on the car — usually greater than 15,000 miles — which will cause the car to depreciate faster than you’re paying down the loan.
• When you buy a new car with a minimum down payment. The typical new vehicle depreciates by at least 20% within the first year (and at least 10% each year thereafter), so if your down payment was substantially less than this, you will be upside down in the early years of the loan. Since cars depreciate so quickly, it’s not hard to be in this position even if you put a substantial amount down.

As you can see from these examples, being in a negative equity position on a car is hardly unusual. For that reason, gap insurance may be necessary.

What does gap insurance cost?

Fortunately, gap insurance isn’t at all expensive. A typical policy will cost less than $100 per year. Since it’s add-on coverage, it works out to be less than 10% of the collision and comprehensive portions of your policy, which itself is usually a few hundred dollars per year. Once the outstanding loan on your car falls comfortably below its value, you can terminate the coverage.

Car dealerships offer the coverage, but it’s cheaper to add it onto your existing auto insurance coverage. And fortunately, you can generally add it onto your policy even after purchasing a new car.

To see if you need gap coverage, compare the outstanding balance of your loan with the true value of the car, sometimes known as “the blue book value.” You can obtain this by entering your vehicle’s information on respected automotive valuation websites such as Kelly Blue Book (www.kbb.com) and Edmunds.com.