I was introduced to gap insurance when I bought my new Honda Element in December 2005. Gap insurance is an insurance product designed specifically for buyers who purchase their new car with financing — in other words, those who will be upside down on their auto loan.
When you take out an auto insurance policy, the insurance company will pay for the repair cost or the fair market value of the vehicle (whichever is lower). However, the fair market value could be lower than what you owe on your car loan due to depreciation. From the illustration below you can see that new cars depreciate quickly and there is a period where you owe more in car loan than the car is worth. This is what the industry call an upside down auto loan.
The purpose of gap insurance is to pay for the difference between the value of your car and what you owe in car loan. For example, let’s say you totaled your car after 15 months. At this time, you have $23,000 left on your car loan, but the insurance company determines that your car only worth $19,000. As a result, you will have to come up with $4,000 on your own to pay off the financing company. However, if you have a gap insurance, it would pay the $4,000 difference to the financing company.
The best place to start is with your current car insurance company. Although your car dealership will try to convince you to buy a gap insurance through them, you’ll most likely pay a higher premium for the same coverage that you can get elsewhere.
Whether or not you should get a gap insurance is really up to you. However, there are a few factors that you should consider:
No, gap insurance is not required. However, the financing guy at the car dealership will do his best to convince you otherwise.
This depends on the leasing company. You should ask the car dealership regarding who would be responsible for the difference if the amount paid by the insurance company were not sufficient to cover the lease. Usually, the lease has this insurance built in, but it’s safer to ask anyway.
There are many ways to avoid being upside down on your car loan. Money Crasher highlighted a few ways as follow:
And I would add these to the list:
What’s your experience with Gap Insurance? Please share…