If you get a vehicle, regardless of whether you buy it brand-new, used, or certified pre-owned, you know that you can’t drive it without the minimum required insurance. If the police catch you driving without that, you could be in serious trouble. Various states also require different insurance policies and amounts, so you need to find out about that before you get out on the road.
GAP insurance is one variety about which some people don’t know. In this article, we’ll explain what it is, why you might need it, and what it can do for you.
What Precisely is GAP Insurance?
To put it as simply as possible, GAP insurance covers the difference, in dollars, between your vehicle’s book value and the amount that you financed to buy it. The reason you may want it is that you might get in an accident while driving the vehicle. When you do, you might total it, meaning that a mechanic tells you the car is a total loss and you can’t use it any further.
If that happens, then generally, your insurance doesn’t legally have to pay you any more than the car’s book value. They determine the book value (usually they use the Kelley Blue Book) by looking at factors like how old the vehicle is, how many miles are on it, and whether there was any appreciable damage or wear before the accident occurred.
If the amount your insurance pays you is less than the car is worth, you have to pay back the remainder of the amount that you financed. It is your GAP insurance that covers this difference, so you don’t have to pay it out of pocket. GAP stands for Guaranteed Asset Protection.
GAP insurance is certainly helpful since the difference between the car’s book value and the amount that you financed can sometimes be thousands of dollars. However, running into GAP insurance issues is also possible since some companies will try underhanded tactics if they think they can avoid paying it.
How Can What You Still Owe on the Vehicle Be Less than the Car is Worth?
At this point, you probably are asking the logical question, “if I financed the amount that the car was worth when I purchased it, then why would there be a gap in the amount that it’s worth when I totaled it versus what the book says its value is?”
The answer is that sometimes, a car’s value can depreciate faster than the loan balance lowers. This can happen if you got a loan that’s structured so that the payment details are not in your favor.
This issue with the vehicle’s value when you total it being less than the amount that you financed happens more often than not if you bought the car brand-new. If you buy a used or certified pre-owned vehicle, it’s not inconceivable that this could still happen, but it’s not as likely.
Crunching the Numbers
As an example, let’s look at a scenario. Let’s say you financed a brand-new car. During the first year that you own it, it loses 20-30% of its value. It will lose 10-20% of its value every year after that as well. Average car loan length is about 5-6 years.
If you look at those numbers, it’s easy to see how, if you crash the car in year three or four, the amount that it’s worth, meaning the book value, will be less than what you still owe via your financing agreement. If you buy a used car and finance it, there will either be no gap between what’s it’s worth when you wreck it versus what you financed, or else that gap will be much less because significant depreciation will already have occurred when you got the car.
This is why it’s sometimes to your advantage to be a car’s second or third owner. The car is worth a lot less when you get it, so you’re not as likely to run into this issue.
If you are going to get a brand-new car, though, or a certified pre-owned one, it’s smart to get GAP insurance. You might want to get a newer vehicle because it has fewer miles and better safety features.
If so, you can feel better while driving it if you get GAP insurance. You’ll know that if someone hits you and totals the car, the insurance will make sure that you’re not on the hook for thousands of dollars.