Can you imagine having a car that you're financing declared a total loss because of an accident or theft — but still having to make payments on it?
Because I sold cars at dealerships for 12 years, I've seen this scenario more times than I can count. People fell into this situation not because of poor planning, some car dealership scheme or cosmic bad luck. It happened because many shoppers didn't fully understand their car insurance policies or what they meant for their auto loans. These car owners assumed that if they were to lose their car to an accident or theft, their car insurance would handle the money part and they'd just go get a different car and move on with their lives.
Unfortunately, it's not that easy, especially if you owe more on your car than it is actually worth.
This is where gap insurance comes in: As the name implies, it covers the gap between what you owe on a vehicle loan or lease and the vehicle's value as determined by the insurance company in the event of a total loss.
Your Insurance Policy Might Not Pay Off Your Car Loan
How would you wind up in that gap? Many car buyers don't know that if the car is declared a total loss because of an accident or theft, their insurance company isn't obligated to pay it off in full. Unless you've bought new-car replacement coverage, it is only responsible to pay market value for the car, which can be far less than what you actually owe. If you owe more on a car than it is worth, that's called being "upside down."
An example: A driver owes $20,000 on a car that is totaled, but her insurance company determines the vehicle's market value is only $15,000. Gap insurance would cover the remaining $5,000 balance.
Being upside down is common. In 2016 alone, people traded in more than 6 million upside-down cars and trucks for newer models. It is a safe bet that millions more owners who are upside down on their vehicles are on the roads. They could be on the hook for thousands of dollars if they were faced with a total loss of their cars.
Are you one of them? Here are some indicators that gap insurance might be right for you:
1. You financed a car and made little or no down payment.
If you didn't make a large down payment, you'll be upside down the moment you drive off the lot. It may take several years of reducing your car's loan balance before the loan amount and the car's actual value amount begin to balance. And if you've bundled the costs of tax and registration into your financing, it will take even longer to hit that even point.
2. You've traded in an upside-down car and added the amount you still owe to your new car loan.
When you trade in an upside-down car, the dealership will add what you still owe to the loan balance of the new car unless you pay that difference up front. This extra balance could come back to haunt you if your car is totaled or stolen.
3. You've bought a car that doesn't have great resale value.
If you've bought a car that traditionally loses value pretty quickly, there is a good chance you'll be upside down unless you've made a substantial down payment. When we say substantial, think 25 percent or more. If you're not sure how quickly your new car loses value, use our True Cost to Own tool to find out.
4. You plan to pile the miles on quickly.
Very few things reduce a car's value faster than lots of driving. If you're racking up miles quickly, you're dropping your car's value quickly, too. And chances are that you're dropping the value faster than your payments are dropping your loan amount.
5. You've taken out a car loan with a long term, meaning more than 60 months.
When you take out a long-term loan, it takes longer than usual to hit the break-even point, which is when your loan balance and the car's value begin to equalize.
What Gap Insurance Costs and Where to Buy It
You can buy gap insurance from some insurance companies and credit unions. Car dealerships offer it during the last stages of deal-making, when you're in the finance and insurance office, signing purchase or loan paperwork. Many lease contracts include gap insurance for free — but not all, so ask if you are going to lease. Buyers who finance their cars will have to pay extra to get gap insurance. Car dealers typically charge between $400 and $600. Some credit unions and insurers sell it for less than $200.
Here are a few things to keep in mind when buying gap insurance:
- Although most people purchase gap insurance when they begin a finance contract, some car insurance companies will sell it after the initial purchase date.
- The insurer might not honor your gap policy if your car insurance doesn't include collision and comprehensive coverage. Lease contracts generally require you to carry collision and comprehensive at all times.
- If someone steals your car or it's totaled in an accident, carefully follow all of your auto insurance company's requirements. For example, some companies require you to continue making car payments on your totaled vehicle until the money from the gap insurance is paid out.
When you're initiating a car loan or lease, ask your insurance agent, loan officer or dealership finance and insurance manager about gap insurance. Do some comparison shopping on price to ensure you're getting a good deal. If you have an accident or theft that results in a total loss, you'll be glad you planned ahead.
To find a dealership that knows how to treat shoppers right, please visit Edmunds.com's Dealer Ratings and Reviews.