When you finance a new or preowned vehicle, the bank or lender puts up the money to buy the car in exchange for agreed-upon monthly payments. If you total your vehicle and its value does not cover the remainder of the loan, you have to pay the balance out of pocket.
With gap or guaranteed asset protection insurance, you will have coverage for this situation and avoid a substantial personal cost in the event of a total loss. With most insurance companies, you can add gap insurance if you also have comprehensive and collision policies. Review this guide if you think you may need gap insurance for a used car.
How Gap Insurance Works
To understand gap insurance, it’s important to understand that cars depreciate, or lose value, as soon as they leave the dealer lot and continue to lose value over time. Let’s say you currently owe $15,000 on a loan you took out to buy a late-model pre-owned vehicle just last year. You have an accident and total the vehicle, but your insurance company says the car was only worth $13,000. Gap insurance would cover the $2000 to pay off your auto lender; otherwise, you would owe the balance and would have to come up with the cash.
Generally, the insurance company totals your vehicle when it would cost more to repair the car than it is worth. Most insurance companies total a vehicle when the repair estimate comes in at more than 75 percent of the car’s actual cash value.
Insurers use sources such as Kelley Blue Book and the NADA Valuation System to decide if your car is a total loss and they will let you know how they came to that conclusion, based on factors such as the make and model, mileage, and condition of the vehicle. If you disagree with the actual cash value as established by the insurance company, you may have to file a lawsuit to claim a higher settlement.
While loan companies require you to carry comprehensive and collision insurance on a financed vehicle, they do not usually require gap coverage. If you lease a vehicle, however, the leasing company may automatically include this type of coverage in the cost of the lease.
Where to Buy Gap Insurance
Bankrate reports that you have three options if you want to purchase gap insurance. You can buy it from your auto lender as part of your loan payments, but that means you will also pay interest on the premium for the policy. You can also buy it from a gap insurance firm or from your existing car insurance provider, which allows you to avoid interest payments.
Major insurance companies that offer gap policies in many states include Travelers Insurance, Safeco, Nationwide Insurance, Liberty Mutual, Auto-Owners Insurance, and American Family. USAA, which writes policies for military members and their families, also provides this type of coverage.
To qualify for gap insurance, you usually have to purchase a policy within three years of buying your car. Your vehicle can be preowned but typically has to be no more than two to three years old. Some companies write gap policies only for a car’s original owner.
Who Should Buy Gap Insurance
The NerdWallet finance blog recommends gap insurance for people who:
- Lease a car
- Finance a car for longer than 60 months
- Buy a brand-new car
- Buy a car that’s less than three years old
- Take out a loan for more than the value of the car after license, tax fees, extended warranties, and negative trade-in equity
- Finance a car without a 20 percent down payment
- Purchase a car that will depreciate in value quickly
In these situations, you may owe more than the value of the car until you make enough payments to gain equity. On the other hand, you can probably opt out of gap insurance if you finance a car for less than 60 months, make a down payment of at least 20 percent, or choose a vehicle that experiences minimal depreciation.
The Cost of Gap Insurance
According to Investopedia, you’ll probably pay just a few extra dollars a month or up to $40 a year for gap insurance. However, this cost varies based on your driving history and the value of your vehicle. The website recommends getting quotes from at least three insurance companies before choosing a gap insurance policy. Usually, the insurance company charges about 5 to 6 percent of the premiums for your comprehensive and collision insurance, also required by your lender.
If you purchase a gap policy through your lender, you can expect to pay about $500 to $700 as a one-time fee. Gap insurance from a third-party firm usually costs about $300.
Alternatives to Gap Insurance
AutoInsurance.org reports that alternatives exist if you cannot qualify for gap insurance on your used car. One such option is loan and lease payoff, which is similar to gap insurance but is also available for older used cars. Instead of paying off the full balance of your loan like gap coverage, this type of coverage will pay about 25 percent of your car’s value in addition to your comprehensive or collision payout your vehicle is totaled. You can get loan and lease payoff if you have Progressive, Farmers Insurance, or Esurance.
You can also consider new car replacement, although this program is also usually only available for vehicles that are less than three years old. With new car replacement, you pay the deductible if you total the vehicle and the coverage pays the value of a new car of the same make and model as your old car. Many insurance companies offer either new car replacement or gap coverage, but not both. Some of the insurance companies that advertise a new car replacement program include Travelers Insurance, Safeco, Liberty Mutual, Farmers Insurance, and Allstate.
Before purchasing a pre-owned vehicle made within the past three years, explore the possibility of gap insurance for your used car if you plan to take out a loan.
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