Here’s an unpleasant thought: you buy a new car and within months it’s stolen or totaled following an accident. You believe that your insurance coverage is excellent, but are soon rudely awakened when your finance company sends you a bill for thousands of dollars. Had you chosen gap insurance, your finance company wouldn’t be demanding payment. That is if you knew about such coverage in the first place.
What is Gap Coverage?
Gap insurance, also known as gap coverage, pays the difference between what you owe on your vehicle and what your car is worth. Gap coverage is especially important if you do not put enough money down on your new car and its value has slipped below what you owe on it.
For instance, you buy a new car and pay $27,500 for it, putting $2,500 down. You take out a loan for $25,000 and five payments later your outstanding balance falls to $23,500.
Unfortunately, you get into an accident that destroys your car, which soon reveals how vulnerable you really are. You file a claim with your insurer and the insurance company sends your finance company a check for $19,500, representing the value of the car minus your $500 deductible. The difference here is $4,000, an amount that your finance company says that you still owe on the loan.
That gap represents the difference between the loan balance and your insurance payment, monies that you must repay.
Going Upside Down
Many car shoppers are “upside down” or “underwater” with their auto loans, a term that also describes some homeowners.
Typically, borrowers are upside down for two reasons:
1), they do not put enough money down, and
2), the car loses a significant amount of its value within the first few months of ownership.
Indeed, it is not uncommon for a new car to depreciate rapidly with Edmunds.com noting that a new vehicle loses on average 11 percent of its value the moment it drives off the dealer’s lot. Several months later the car’s value may fall by 25 to 30 percent, making it entirely possible that you owe more to your finance company than what your insurer says it is worth.
Gap Protection Coverage
You may not need gap protection if you put 20 percent or more down and your loan term is short, such as for 36 months. Some consumers make the mistake of rolling their related fees and taxes into their loan and perhaps adding extended warranty coverage as well.
One way to make sure that you are not buying a car that will immediately put you underwater is by using an auto loan calculator such as the one that’s available online from Bankrate.com. Then, compare that number with what Kelly Blue Book lists as your vehicle’s depreciation rate.
As long as you owe less for your vehicle than what it is worth, then you are okay.
Buying Gap Insurance
Before you run out to buy gap coverage, you should review your loan purchase agreement as you may already have it. Such coverage is more common if you lease a vehicle than if you were to finance one. In any case, your finance company may have added that coverage with your agreement.
Indeed, some lenders require gap coverage because they know you may find it difficult to settle the difference later on.
Your current insurer may offer gap coverage, a small cost that’s added to your auto insurance bill. Contact your insurer to get a quote for the gap or actual cash value insurance.
Keep in mind that you will still have to pay a deductible and may receive less money if your car has high miles or is in poor condition. You can cancel gap coverage once you determine you are no longer upside down.
Avoid a Financial Catastrophe
Gap coverage may save you from financial calamity, enabling you to get back on your feet quickly. Without such coverage, you may find yourself unable to afford a replacement vehicle, worsening an already serious problem.
See Also — 7 Ways to Trim Car Insurance
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