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Do I Need Gap Insurance?

Just bought or leased a new car? What if you get into an accident soon after taking your brand new car off the lot? If you assume that you are fully covered because of your collision coverage, think again. This is where Gap Insurance (sometimes called Loan/Lease Insurance) can come in handy.

When You are Upside Down on Your Car

The old saying about your car losing value the minute you drive it off the lot is absolutely true. So, during the early years of a car loan or lease, depending on how much you borrowed to finance the car, it's easy to be “upside down” on your car, meaning that you owe more on your car loan or lease than the vehicle is worth. If you're in an accident, and your car is totaled, the insurance carrier is only responsible for paying for the replacement value of the car (i.e., the market value of your car). So, if you are upside down at the time of the accident and owe the bank or lessor more than the replacement value of the car, the settlement amount you receive from the insurance company will be less than the amount you owe. Unfortunately, you are responsible for the difference and may find yourself in the unenviable position of continuing to make payments for a car you no longer have.

Let's look at a real world example: Say for instance you paid $25,000 for your new vehicle and borrowed the entire purchase price. Say that you have an accident a month later that totals your new car. You've probably only made one payment on the car, and so your loan amount is still close to the $25,000 you originally borrowed. Unfortunately, even with full comprehensive or collision coverage, you will only receive the market value of your vehicle, which will be as much as 20%-30% lower than the purchase price (remember -  a new car depreciates significantly the minute you drive it off the lot). That means you may be stuck paying that 20%-30% out of your own pocket. On a $25,000 car, just a 20% depreciation would be $5,000! That amount could be more if you financed your taxes and license into your loan.

How Can Gap Insurance Help?

GAP stands for Guaranteed Auto Protection. But, most people just use the term "Gap" to represent the gap in coverage between how much one owes on a car and how much the car is worth. Gap coverage is insurance that pays for the difference between how much you own on the car (either through a loan or lease) and what you are reimbursed from the insurance company in the event of a total loss. If you are financing or leasing a new vehicle purchase and putting very little (or no) money down, you need to consider getting Gap insurance to protect you financially from a major accident in the first 1-2 years after purchase that results in a total loss of your car.