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Gap Insurance: What Is It and Do You Really Need It?

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Having proper car insurance coverage is crucial. But understanding it can be a challenge.

Let’s shed some light on this complex world so you can find out what gap insurance is and if you really need it.

Most places have minimum requirements for liability insurance. This type of insurance helps pay damages you might cause to other people or their property. Almost every single car insurance policy includes liability insurance.

Comprehensive insurance or collision coverage helps you recover the value of your property. If you use an auto loan, your bank or credit union will require you to have collision insurance. Some leases require this insurance too.

But what about gap insurance? It’s seldomly required, but sometimes it can be a good idea to have. Let’s discuss this in more detail to find out.

What is Gap Insurance?

Gap insurance works by paying off your loan balance in full, even if the insured item’s value is less than what you owe.

It is usually only effective in cases of total loss protection of a vehicle, meaning the car is totaled. Insurance companies total cars when repair costs exceed the cash value.

Although most commonly sold when the vehicle is new, gap car insurance can occasionally be provided even if the vehicle is not new.

It helps provide guaranteed asset protection and protection against negative equity.

Loan Balance vs. Insured Value

When you purchase a new vehicle through a car loan at a bank or a credit union, they will often lend you the amount you need to purchase the car.

They might also cover some additional costs like a destination freight charge, additional taxes, or another out-of-pocket expense.

The amount that you owe on your auto loan will decrease over time as you make regular payments. The more payments you make, the more the loan balance goes down.

At the same time, if you get a new vehicle, you will need to get auto insurance to cover the value of the vehicle.

You pay a premium to an insurance company, such as Wesco Insurance Company, which provides insurance coverage.

Most auto loans through federal credit unions and banks will require you to get comprehensive coverage, also known as collision coverage.

The car insurance company pays to repair the vehicle if it is in a collision. Or they pay the fair market value if it’s totaled.

Totaling a car means the insurance company found that the repair cost is more than the total value of the vehicle. This can be based on actual cash value or fair market value.

When this happens, the insurance company will pay out the insured value. Problems arise when the loan balance owed is higher than the insured value.

Negative Equity

Usually, there’s some difference between the fair market value and loan balance. This can work out in one of two ways:

  • If you pay off your loan quickly, the market value is more than your car loan. In case of a total loss, you can pay off the remaining loan balance and have cash left over to purchase a replacement vehicle.
  • On the other hand, if the value of your vehicle drops quicker than the loan balance, you could be in a difficult position. The car insurance company might try to pay you an actual cash value less than the loan balance, leaving you on the hook to pay the rest of your loan balance even though the vehicle is totaled. This is where gap insurance can help out.

This situation, where your loan balance exceeds the fair market value of your vehicle, is known as negative equity. It’s best to avoid having negative equity in any asset, but sometimes it’s unavoidable.

By purchasing a gap car insurance policy, you will be protected against any negative equity you might have. The insurance provider will pay off the entire loan balance, even if the market value is less than the loan balance.

What Does Gap Insurance Cover?

We’ve gone over the basics of gap insurance and when it comes into play.

It helps pay off your loan balance even if the insured value is less.

Now let’s go deeper into each situation when gap insurance helps cover your financial wellbeing.

Loan Covers Excess Costs

Purchasing a vehicle comes with many expenses. You’re not just paying for the vehicle’s market value, you’ll also have some transaction costs, potential taxes, registration fees, and other out-of-pocket expenses.

In some cases, the additional costs can add up to thousands of dollars. That might not be easy to come up with in cash.

But rather than put it on a credit card with a high-interest rate, some banks and credit unions allow you to include these costs in the car loan.

Doing so can be a smart move, but it also might lead to instant negative equity. Since you borrowed more than the car is worth, you already owe more than the car insurance company might pay.

But if you get a gap insurance policy, then you’re covered. The insurance pays off your entire balance if your vehicle is totaled. This includes any additional expenses you borrowed.

Car Value Drops Quickly

Another situation when gap car insurance is quite helpful is when the value of your vehicle drops quickly.

Even if you only take out a loan to cover the value of the car, that value can change quickly.

As soon as you drive cars off of the sales lot, many face an immediate drop in value. If you turned back around and sold it back to the dealership, they’d probably offer you much less than what you just paid.

On cheaper, older cars the amount might be trivial. But on expensive new cars, it can be thousands of dollars.

Car values can change rapidly and without warning. You might love your vehicle. But if the general market doesn’t, the fair market value might drop quickly.

One major recall can taint a car’s image for years on end, causing the value to plummet and stay low.

Gap insurance can help out. Even if your vehicle’s fair market value drops below your loan balance, your insurance company still pays off the loan in full. Giving you peace of mind and making it so you don’t need to worry about the value of your car.

Long Loan Terms

Paying off a car loan can be a challenge. And some people prefer to take out long loans to get smaller monthly payments. This helps monthly budgeting and can work out well if you hold onto your car for many years.

However, this can also cause your loan balance to drop slowly. If your monthly payments stretch out over a longer loan period, then you might face a situation where the loan balance is higher than the value your car insurance company will pay out in case of total loss.

Anything 5 years (60 months) or longer are considered long loan terms. If you have a loan in this range, then gap insurance could help cover your financial wellbeing. Don’t get caught without guaranteed auto protection.

Leased Vehicle

We’ve been talking primarily about car loans through banks and credit unions. But that’s not the only time when gap insurance coverage is crucial. Leased vehicles are too.

If you have a leased car, then the loan balance and negative equity won’t be in the picture.

However, the lease provider might require you to get gap coverage. In a lot of cases, this is true.

Make sure you understand what the terms of the lease are. If needed, include the additional price of gap insurance cost into your decision-making process while looking to lease a vehicle.

Do I Really Need Gap Insurance?

None of these situations seem familiar to you? Perhaps you know you’re paying taxes and other fees out of pocket.

You feel confident that your car’s value will hold up well. And you’re getting a short-term loan that you mean to pay off quickly without a lease.

Then maybe gap insurance isn’t for you.

But here’s the thing. There is a lot of uncertainty in the insurance world. When your car is totaled, you could be shocked to find out that the total loss protection you thought you had didn’t cover the fair market value.

Your homeowner’s insurance or flood insurance policy won’t help out. You might have negative equity in your vehicle without knowing it, even if you’ve read everything the Insurance Information Institute has to offer.

Sometimes the used car market simply doesn’t match the amounts that insurance companies payout, even ones underwritten by AMT Warranty Corp.

So even if you see your vehicle selling for high prices, the insurance payout might not cover your loan balance.

The gap advantage means that you don’t have to worry about that. Regardless of your vehicle’s value, the insurer will always pay off the loan balance.

How to Get Gap Insurance?

If you’ve decided you want to purchase gap car insurance coverage, then you should discuss this with your insurance provider. You can talk to your auto insurance company directly.

Sometimes you can purchase this type of coverage through your credit union or dealership financing.

Although commonly called gap insurance, the National Credit Union Administration found that gap coverage does not technically meet the definition of insurance and can be sold by credit unions.

Get a Quote Today!

Reach out to one of our favorite gap insurance providers and get a quote today

Gap auto insurance is most often sold with brand new vehicles, as they are the ones that can get into negative equity the easiest. If you are buying a new vehicle, discuss gap coverage before finalizing the paperwork.

But if you have already purchased a vehicle, even a used vehicle, then you still might be able to add gap coverage to your policy.

Just like how you can add collision coverage at any time, many insurance companies will add gap coverage upon request depending on the rights reserved.

You’ll want to have a few things handy. These include your driver’s license, car insurance information, and vehicle information including year, make, model, trim, and vehicle identification number.

Then call your auto insurance company, car dealer, or credit union to find out if they offer gap insurance coverage.

Final Words

If your loan balance exceeds the value of your vehicle, then gap insurance coverage could prove to be quite helpful. It will pay off your loan balance even if your car insurance company values your vehicle at a lower amount.

Gap insurance is helpful for those purchasing a new car, for those with long lease terms, and if you want to have other out-of-pocket expenses covered. It’s also commonly required for vehicle leases.

Don’t get caught paying off a loan for a vehicle that doesn’t exist anymore. Consider gap coverage if it’s right for you.

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