(The Financial Literacy Blog) – If your vehicle were to ever be totaled or stolen, finding out you owe more on the vehicle than it’s worth would make an unfortunate situation ever worse. If you have collision or comprehensive insurance, that can help pay for the loss as a result of damage or theft. However, it’s important for you to know that the insurance company will pay the value of your vehicle in a total loss settlement, not what you owe on the auto loan. If you owe more on the loan than what the vehicle is worth, gap insurance can come to the rescue.
How Does Gap Insurance Work?
Let’s say you were in an accident that totaled your car and you still owe $30,000 on your auto loan. At the time of the accident, your car was worth $25,000. Because you had collision and comprehensive insurance, the insurance company paid for the value of your car, minus your $500 insurance deductible. That means the insurance company paid $24,500––leaving you solely responsible for paying the remaining $5,500. However, if you had gap insurance, you would pay the $500 deductible and the gap insurance would cover the remaining $5,000.
Is Gap Insurance Required?
No, gap insurance is not mandatory. It’s an optional insurance that protects you from depreciation. When you buy a vehicle, its value starts to decrease––even as soon as simply driving it off the lot. According to Experian, new cars depreciate as much as 20% in value after the first year of ownership and then continue to depreciate by 10% or so each year after that. Gap insurance protects you from this loss of value when you make an insurance claim.
How Much Does Gap Insurance Cost?
On average, gap insurance adds $60 per year to your annual auto insurance cost. Once you add gap insurance, it applies for the duration of your policy. However, you won’t need gap coverage for the entire length of the loan. After you make enough auto loan payments, you’ll eventually owe less than what the car is worth. When that happens, you can drop your gap insurance.
Where Can You Get Gap Insurance?
You can purchase gap insurance with the insurer that is providing you with collision and comprehensive insurance and incorporate it into your regular payment. You can also purchase gap insurance through the dealership or your lender—where you can roll the cost into your loan payments. Check with your local credit union to see if they offer gap insurance.
While completely optional, gap insurance can be a valuable safeguard. Whether you have a current auto loan or you’re looking into purchasing or leasing a vehicle in the future, this coverage can lessen the financial strain of a vehicle loss.