GAP Insurance

What Is GAP Insurance On An Auto Loan? 5 Things to Know

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Gap stands for “assured auto protection” in the insurance jargon. Temporary auto loan coverage is required only when the loan amount exceeds the car’s current market value. The insurer will cover the difference if you have gap insurance and your automobile is totaled in an accident. This isn’t something typically covered by standard auto insurance.

Automobile owners can protect themselves from financial ruin in the event of a total loss by purchasing gap insurance, designed to pay profit from the gap between the car’s value and the balance still owed on the loan or lease.

This “gap” between the car’s depreciated value and the loan balance is what gap insurance protects against. To find out whether and where you need GAP insurance and what exactly it is, read the article below:

auto insurance

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1. The Meaning of Auto Gap Insurance

Covering the financial gap between the vehicle’s actual cash worth and the loan or lease sum is what gap insurance is all about. The purpose of gap insurance is to compensate for the financial shortfall that results when your auto insurance payout and the amount still owed on your vehicle in case of a total loss or theft before the loan is paid off.

Lenders often stipulate that buyers of certain automobiles (including pickup trucks and sport utility vehicles) have gap insurance when financing their purchases. Specifically, this includes luxury sedans, sport utility vehicles, and other forms of sport utility vehicles, which may experience greater than average depreciation and value loss rates.

Some life insurance companies also provide GAP coverage; however, you must consider how much does life insurance costs if it is covering GAP, as it may cost higher than usual.

2. Buying Gap Insurance: Necessary or Not?

You may know the expression “upside down” regarding mortgage debt. The same idea applies; whether a home or a car, the financed object has depreciated and is now worth less than the outstanding loan total.

You shouldn’t worry quite so much. The amount you own of a house or car decreases significantly if you put a small amount down and pay the remainder in manageable monthly chunks spaced out for five years or more. You reduce the principal balance, your debt decreases, and your equity increase. It would be best if you got gap insurance to make up the difference in case of an accident and avoid financial responsibility for the car’s depreciation.

Buying Gap Insurance Necessary or Not

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3. The Operation of Gap Insurance

In the first few years of ownership, it’s common for a motorist to owe more on their car’s loan or lease than the vehicle is currently worth. You can do it with a small down payment and a long loan or lease time until your monthly payments have built up enough equity in the car.

When calculating the value of a vehicle for insurance purposes or when selling it, equity must equal the purchase price. Your standard auto insurance policy will pay out at that value, not the amount you paid. Depreciation is a major issue for new automobile buyers, especially in the first two years of ownership. On average, a car’s value drops by 10% in the first month following purchase.

Your insurance policy probably won’t help you buy a new automobile if yours is totaled in an accident. You’ll receive an amount equal to what a used vehicle like yours would fetch on the market. The real cash value of a car is the term used by insurance companies.

Unfortunately, that’s not a gap that gap insurance would cover. You may suffer less of a financial hit because rewards are determined by the items’ current market worth rather than their replacement cost.

4. Gap Insurance For Your Car Might Be a Good Idea if…

If you fall into any of the following categories, as outlined by the Insurance Information Institute, you should seriously consider purchasing gap insurance along with your new vehicle:

  • Used a down payment of less than 20%
  • Paid out over 60 months
  • The car was rented on a lease (carrying gap insurance is generally required for a lease)
  • Bought a car with a higher rate of depreciation
  • Converted an automobile loan with negative equity into a positive-equity loan.

Contrast: Gap Insurance vs. Replacement Cost Coverage

Some auto insurance providers offer a coverage option known as replacement value insurance or new car replacement insurance. If your automobile is totaled, you can receive the cost of a brand-new vehicle of the same make and model (less your deductible) rather than the depreciated value. A good alternative to gap insurance is this coverage.

In most cases, you will only be able to get this coverage if your vehicle is a certain age and has a low enough mileage. Furthermore, you can only get it if you pay extra for collision and comprehensive coverage. However, if you meet the requirements, this policy can fully substitute for gap insurance.

Gap Insurance For Your Car Might Be a Good Idea if

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5. Benefits and Drawbacks to Having Gap Insurance

These days, acquiring a brand-new automobile is a financially daunting task. More than $32,000 is required for the typical financing of a brand-new vehicle. The typical loan duration has increased to 70 months.

Even if your lender lets you avoid collision insurance, you won’t dare. However, if you owe more on your automobile than it is worth, gap insurance could be a useful addition to your collision coverage. In an accident, the payout from collision coverage will be that much.

Assuming you put down less than 20% and financed the vehicle for five years or longer, you may experience this in the first few years of ownership. Consult the Kelley Blue Book to determine if you need gap insurance. Is the value of your car below the amount still owed on your loan? If that’s the case, consider getting gap insurance.

Final Thought

Unless stipulated otherwise in your lease or loan agreement, gap insurance is normally a voluntary product. However, spending a lot of money on a new car might provide you with much-needed peace of mind. One strategy to save money on auto insurance is to drop gap coverage after you no longer have a financial need.

Image source: istockphoto

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