What is gap insurance for your car? It sounds like something that covers the crack your teenage son put in the front bumper, but it does not refer to a physical gap. It refers to a gap in value – the gap in the book value of your car versus what you still owe on it.
Because depreciation is rapid and car payments are generally the same monthly amount, gap insurance exists to cover the early period in the ownership of your car when the amount you have paid on your car is considerably less than the amount you owe – especially if you purchased your car with little or no down payment.
As soon as you leave the dealer’s lot, the value of your car drops significantly (as it is now used). The typical depreciation is around 30% over the first year and around 50% after three years of ownership. If your car were totaled (theoretically, by that same teenage son) at that 30% value point, you will have made only one year’s worth of payments – leaving your insurance settlement thousands of dollars short of what you owe on the car.
Why buy gap insurance? Here are some of the primary reasons:
- Type of Car – The value of your car and how quickly that model depreciates will determine how large of a gap you have to cover. You can look up auto values for reference online at the Edmunds or Kelley Blue Book websites, among others, to check the depreciation rate by comparing values for different model years. The faster the model depreciates, the more useful gap insurance becomes.
- Size of Loan – Compare the depreciation rate above with your auto loan payment schedule to determine the approximate size and length of the gap you need to insure. If your auto loan payment schedule is not laid out for you, there are calculators online to help you do it yourself.
In general, low or no-down payment purchases are good candidates for gap insurance over the first few years, especially for higher-dollar vehicles.
- Risk – If you drive frequently, in higher-risk areas or times of day, and you or one of the other drivers in your family would be considered high-risk, gap insurance is a more attractive option.
- Leasing – Leasing is an excellent reason to have gap insurance, and some dealers require that you carry it. Even without the requirement, gap insurance is often offered in the lease agreement – but if it is not, you may want to consider adding it yourself.
Gap insurance is usually in the range of 5% of the premiums for collision and comprehensive coverage. It is often below $50 annually, a pretty good bargain if you have a relatively new car and high-risk drivers. You can often save money by buying gap insurance as an addition to your existing policy (as long as you manage not to total your car before you contact your car insurance company).
Make sure that you understand what is covered by your gap insurance so you can assess its value – for example, does it cover theft as well as accidents?
In summary, gap insurance may be right for you if there is a period of time where you owe significantly more on your car than it is worth, or if you are in a non-equity situation like leasing. Don’t forget to factor in the presence of your teenage son (or daughter). Next time, it may not be just the bumper.