Many drivers with full comprehensive and collision insurance coverage on their new vehicles might mistakenly feel that even in the event of a total loss (an accident in which a vehicle is so badly damaged that the insurance company will give the car to a junkyard and write a check to the policy holder rather than pay to fix the car) that the insurance company will cover everything. This is not true. The insurance company will only pay the actual cash value of the car, which is usually going to be less than the loan amount, or what you owe.
Before going any further, in case you are involved in a major collision, you really need to know. There are some steps you need to take to protect yourself so please do take note beforehand.
Now that you understand what to do if you do get into a car accident, let’s get into gap insurance. For example let’s say you buy a new car, with tax, title, everything out-the-door for $30,000. You put a down payment of $5,000, and the rest — $25,000 — you take a loan out for. If you’re lucky and benefited from a manufacturer’s low interest rate or even 0% interest rate loan program, you’ll be feeling pretty secure financially about your purchase decision. But as soon as you’ve signed paperwork and driven the car home, the car has lost a lot of value as it is now considered a used car. By the time it’s parked at home in your garage, it might only be worth $27,000.
Should it happen that your “new” car gets in a major accident or is stolen when you still owe most of your loan to the bank, you’ll probably be upside-down, which means you’ll still have to pay off the rest of your loan, which could be thousands of dollars — for a car you don’t even have anymore.
For example, if something happens to the car before your first payment, you’d owe $25,000 on your loan, after the $5,000 you put down. But the insurance company might only value your car at $27,000, what they determine to be its actual market value (basically what it could be sold for as-is). So they’d write you a check for $27,000, you’d use $25,000 of it to pay off the remaining loan and have a net of +$2,000. But you’ve lost the $5,000 you used for a down payment, so in reality you’re -$3,000 in the hole.
Gap insurance is insurance that covers this difference. If you have gap insurance, that coverage would pay the $3,000 you’d have lost if you didn’t have it otherwise. They basically cover the “gap” between what you owe and what the insurance company will pay you. (GAP is actually an acronym for Guaranteed Asset Protection but metaphor is an easy way to understand its role).
Gap insurance is generally around $500-$700 if purchased at a dealership, but can be had for purchased directly from your insurance company for much less. Call your agent and ask if they provide the coverage and compare quotes between the dealer and the insurance company before you purchase your new vehicle.