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What is GAP coverage and do I need it?

Did you know there are only two states where auto insurance isn’t mandatory? They are New Hampshire and Virginia. The remaining states each have their mandatory limits on the different types of auto insurance. 

While you’re probably familiar with liability insurance and collision coverage, you can also purchase lesser-known supplemental auto policies. One of these is GAP insurance. So what is GAP coverage, you ask?

Keep reading to learn everything you need to know about GAP insurance, including cost and who should buy it. 

What Is GAP Coverage on a Car?

GAP stands for guaranteed asset protection. Car GAP insurance covers the difference between the following:

  • The insured value of a vehicle
  • The balance of the loan or lease the owner needs to repay

If you total your vehicle or someone steals it before you pay off the loan, GAP insurance will cover the difference between your insurance payout and the amount you still owe on the vehicle loan.

In the first few years of owning a new car, it’s easy for you to owe your lender more than your car is worth. This happens when you make a small down payment and have a longer loan or lease period

But when you file an insurance claim, the car’s equity is its current value, not the price you paid. As a result, the insurance company will only reimburse you for the current value. This is a problem since cars depreciate or lose value quickly in those first few years. 

A brand-new car loses 9-11% of its value when you drive it off the lot! After a year, the average depreciation rate is 20%. 

So if you’re in an accident or someone steals your car, the insurance company will pay you the actual cash value of the vehicle, not the cost of replacing it with a brand-new car. 

GAP insurance payouts are based on the actual cash value, not the car’s replacement value, to help minimize financial losses. 

Some auto lenders require drivers to have GAP insurance for specific types of:

  • Cars
  • SUVs
  • Trucks

It usually includes vehicles that depreciate faster than typical of the market rate of 20%. Common examples include luxury and sports vehicles.

How GAP Insurance Works

To better understand how GAP insurance coverage works, let’s look at an example:

In April 2021, you purchased a new car for $30,000. You put 10% down on the car and took a five-year (60-month) loan for $27,000. For argument’s sake, you have a zero-interest loan; lucky you!

This means your monthly payment is $450. 

However, in April 2022, you got into a terrible car accident. Your insurance company says it’s a total loss. They owe you the entire current value of the car.

So far, you’ve paid $5,400 on the loan, so you still owe $21,600. 

But remember, cars depreciate. So in April 2022, your vehicle was worth 20% less than you paid for it in 2021. The total worth is $24,000.

Your collision coverage reimbursement ($24,000) will be enough to cover the remaining balance on your loan ($21,600), and you’ll have $2,400 leftover to put towards a new car. 

In this case, you wouldn’t need GAP insurance because you’ll receive more money than what you owe on the loan. 

However, what if your car depreciated faster? Let’s say instead of 20%, your vehicle depreciated at a rate of 30%. In that situation, your vehicle is now worth $21,000. Your collision reimbursement would not cover the total you still owe on the loan ($21,600). 

You would owe your lender $600 out-of-pocket to finish paying off the loan after receiving $21,00 from your insurance company.

How Much Is GAP Insurance?

The price of GAP insurance depends on where you buy it from. There are three primary ways to purchase GAP insurance. They are:

  • From your auto insurer
  • Through the dealership or auto loan lender
  • From a company that explicitly sells GAP insurance

GAP insurance can be inexpensive when you add it to your insurance coverage from your current auto insurer. The average price is around $20 a year when you do it this way. Most of the biggest auto loan providers in the US offer GAP insurance as an add-on.

If you add GAP insurance to your auto loan or buy it at the dealership, you will pay a lump sum. The lump-sum cost of GAP insurance can range from $450-$750. This option is often the most expensive. 

You can also buy a stand-alone GAP insurance policy. Instead of paying annually, you can get a stand-alone policy for around $150-$350. You can shop around with different GAP insurance providers to find the best deal. 

Is GAP Insurance Worth It?

For many people, GAP insurance isn’t worth it. For some, it’s not necessary at all.

If you don’t have a lease or car loan, or you already paid your loan down below the value of your car, you don’t need GAP insurance.

Consider these metrics to help determine if GAP insurance is worth it for you:

  • You paid at least 20% down when you bought the car
  • Your car loan is less than five years
  • The vehicle holds its value better than average 

You can consult the National Automobile Dealers Association (NADA) guide or Kelley Blue Book to understand better how much your car is worth. 

Compare the current value to your loan balance. If your balance is less than your car’s value, there’s no “gap” to cover.

Who Benefits from GAP Insurance?

Although many don’t need GAP insurance, some people still benefit from having it. GAP insurance is something to consider if you put down less than 20% on your car or are financing the vehicle for 60 months (or longer). 

As discussed in the example above, you also want to think about getting GAP insurance if you’re purchasing a car that depreciates faster than average. 

Further, GAP insurance is something to consider if you’re going to lease a vehicle. This is because you won’t own the car, but you’ll be responsible for it during its highest depreciation years.

So GAP insurance could save you from paying any out-of-pocket costs if a major accident or theft happens with a leased vehicle. 

Plus, many leased vehicles tend to depreciate faster than the market rate.

Finally, those with negative equity from an old car loan rolled over into a new loan might consider GAP insurance. It will help protect against further financial losses if someone totals the car.

Recommended reading: The Definitive Guide to How Long People Keep Their Cars

GAP Insurance Alternatives

GAP insurance is just one of several ways you can protect your car in the case of a total wreck or theft. Two other options to consider are new-car replacement insurance and better-car replacement coverage. 

New-car replacement insurance is more expensive than GAP insurance, but it helps you pay for a new car of the same make and model, minus your deductible when you need to replace your vehicle. 

Better-car replacement coverage gives you money for a newer model with less mileage if your insurance company declares your current vehicle a total loss. 

If you’re shopping around for GAP insurance, inquire about other add-on options. You may find something more suitable for your needs.

How Do I Know if I have coverage?

To check whether you have GAP coverage or not, first, contact your insurance company. They can tell you precisely what policies you have and what each one covers.  

If you don’t have GAP insurance with your insurer, review your vehicle purchase agreement. Since you can get GAP insurance when buying a vehicle, your purchase agreement will state if you purchased it along with the car. 

For those leasing a vehicle, you can also check your leasing contract to see if it includes GAP insurance. Remember, some leasing agreements require GAP insurance, so it doesn’t hurt to double-check your contract.

When all else fails, contact the dealership you bought or leased your car from to help you determine if you already have GAP insurance or not. They will be able to view your records and answer any questions you have. 

Do You Need Gap Insurance?

After all this, you may still be wondering, “Do I need GAP insurance?”

Frankly, most people don’t need GAP insurance.

But you can follow this guide to see if GAP insurance is right for you. Even if you buy and never use your GAP insurance, it will provide you with peace of mind should anything happen to your car in the first few years of ownership.

If you can afford it and have a “gap” to cover, there is no harm in adding it to your current auto policy.

When You Buy a New Car consider coverage

With the answer to the question, “What is GAP coverage?” and some essential information about the topic, you can decide if this insurance is right for you. 

If you don’t currently need GAP insurance, you can always consider it when you buy a new vehicle. 

Ready to buy a new car now? Get pre-qualified for an auto purchase or lease from AutoSwiftly today. We’ll simplify the car buying process so you get your dream car at an unbeatable price.

Recommended reading: Pros and Cons of Car Buying Service vs Dealers

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