All About Gap Insurance

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Is gap insurance something you need? The answer, as usual, depends on your unique situation. (Photo: @Wutzkoh via Twenty20)
Gap insurance is one of those terms that you hear tossed around, but you may not have a firm idea of what it actually is. With the variety of insurance types out there, it would be understandable if someone offered to sell you gap insurance and you didn’t know how to respond. But if you know all about gap insurance, you’ll be in a position to make a good decision should the opportunity arise.

What Is Gap Insurance?

The essential term here is “gap,” which can be understood in two ways:
The first way is as an acronym: Guaranteed auto protection insurance.
The second way is in the sense that gap insurance takes care of the “gap” between what you owe on a car and its actual value.
In essence, these two ways of understanding gap insurance amount to the same thing, which is coverage of the difference between your car’s value and what you owe on a car loan.
This “gap” exists only because of what is known as instant depreciation. If you go into a car dealership and purchase a new car for, let’s say, $40,000, then the moment you drive the car off the lot, the value drops significantly. It is the same exact car as before you purchased it, but the value drops because it is technically now a used car. The profit that the dealership makes is built into the original price but not into the actual value of the car.
This might not be so bad if it weren’t for the fact that you have a loan on the original sale price, but the insurance will only cover the actual value of the car as it now stands with depreciation built in. That means that there is a potentially significant amount of money that you would need to continue paying on the car loan even if the car is totaled, the insurance is paid out, and you buy a new car.

Is Gap Insurance Something You Need?

At the dealership, for example, a salesman may frighten you into a bad financial decision by insisting on the need for gap insurance. But their prices are likely worse than other sellers. Just as dealership loans tend to have worse interest rates, this same principle applies to gap insurance.
The best price on a gap insurance policy will, of course, depend on a variety of factors specific to you, but a general rule is that you can probably find a better deal shopping around than at the dealership.
An important detail to keep in mind is that gap insurance is only a temporary policy to have in effect. Remember, gap insurance covers the gap between the value of the car and what you owe, so once you are no longer “upside down” on your car loan, you don’t need the gap policy anymore since that “gap” no longer exists.
For each car, the amount of time it takes to get right side up on your loan will vary based on cost, the length of the loan, and the size of the down payment. If you put down a large enough down payment, for example, you may never actually be upside down on the loan, which means gap insurance would not be a good buy for you.
Purchasing a gap policy is not always wise for everyone. While a gap insurance policy is generally inexpensive, if you do have enough money saved up to cover the costs of whatever the “gap” might be, gap insurance may be a waste of money for you. Then again, if something does happen to your vehicle, you’re probably going to regret not spending a little to save a lot.
In the end, deciding whether gap insurance is right for you depends on your specific financial situation and a number of other factors.
Gap insurance is a good buy for some people and not for others, and understanding a bit more about it goes a long way toward telling you which group you fit into.