The typical American driver spends approximately $78 on car insurance every month.
Car insurance is critical. But do you understand the implications behind the fact that your vehicle has less value now than when you first bought it? Keep in mind that the moment you drive that new car off the lot, it loses around 20% of its value.
If you are servicing a car loan, you likely owe the financier more than you can make off of selling the car. So what happens if you get into an accident and the car gets written off? Gap insurance is a policy that can help solve that problem.
If you’re asking, “how does gap insurance work,” here is a primer to get you started.
What Is Gap Insurance?
Gap insurance is a type of auto insurance policy that helps you cover the shortfall between what you owe on your vehicle and what your insurance provider will pay for it after a loss. The losses that qualify you for gap insurance include theft and accidents.
The moment you purchase a vehicle, what you pay for it is more than what you can get for it if you were to sell it. In addition to this, there are several costs that you might have added on to your car loan (or lease) that you can’t recover. These costs can include title fees, sales taxes, registration, and emission fees, among others.
Should you get into a car accident, what you will be on the hook for with your financier is more than what the insurance company can compensate you for the car.
Gap insurance is typically an add-on policy to your collision and comprehensive cover. You aren’t bound to purchase it as part of the minimum car insurance requirements.
How Does Gap Insurance Work?
To help illustrate how gap insurance works, imagine you’ve just bought a vehicle worth $10,000. Let us further say that due to extra costs on top of your auto loan, your total debt stands at $15,000 as soon as you drive the car off the lot.
If you were to get into an accident with your new car and it gets totaled, you will still owe $15,000 worth of car payments to your financier.
Since your insurance provider reimburses you based on the book value of the vehicle, you can only receive $10,000 as compensation at most. That leaves you with a deficit of $5,000 you need to pay your financier, on top of not having a car anymore.
When you buy gap insurance, the policy can help you pay off the outstanding $5,000 to your financier in place of the remaining car payments.
Getting a Refund from Gap Insurance
What happens if you have gap insurance but end up paying off your car loan early? You may be entitled to receiving the unused portion of the gap coverage.
For example, if you had a 36-month auto loan with a gap insurance policy for 36 months but cleared the loan after 24 months, you may be entitled to the remaining 12 months, depending on your state’s rules.
In many states, the insurance provider will most likely not alert you if a refund is coming your way. Thus, it is imperative that you keep your original contract (or insurance information), the payoff letter, and the odometer disclosure statement safely.
Furthermore, you should make it a point to scrutinize an insurance company’s gap insurance refund policy before you buy the coverage. You can also get in touch with your state’s insurance commissioner office or the commerce department to know the laws and regulations governing gap refunds in your area before you buy the coverage.
Such information will prove useful when dealing with an insurer that does not want to process your gap insurance refund.
When You Should Buy Gap Insurance
While not everyone needs gap insurance, some compelling situations make having gap coverage critical.
1. High Depreciation
When you buy a car that depreciates at an unusually high rate, then gap insurance becomes critical to ward off exposure to risk.
2. Low Down Payment
Did you issue a down payment that was less than 20% when buying your car? It is possible that what you owe on it is more than what you can get from selling it. Since it may take up to several years for the loan amount to equal the car’s book value, gap insurance is critical to protect you in case the vehicle is written off.
3. Longer Financing Period
When you take out an auto loan that has a tenor of more than 48 months, the shortfall between its book value and what you owe is high. Thus, it will take you much longer to get to the point where what you owe the financier is equal to the car’s resale value. Taking out gap coverage in such a scenario is advisable to protect you from a potential write off.
4. Trading in an Upside-Down Vehicle
Whenever you trade in a vehicle of which what you owe the financier more than its release value, the dealership will add the previous outstanding loan to the new one. Should your car get totaled or stolen, that balance can prove to be a real problem. Having gap insurance can help you reduce your exposure to such a risk.
5. You Plan to Use the Car Heavily
If you know you’re going to put a lot of miles on the vehicle, gap insurance is a must-have. The more you use the car, the steeper its resale value falls. Since the depreciation might happen quicker than your payments can keep pace, you soon end up with a significant rift between your car payments and its release value.
Gap coverage in such circumstances can offer you a softer landing should you have to take a total loss on the vehicle.
Don’t Be Caught Flat-Footed
Car insurance is essential. More so, if you know that you are financing your vehicle, and therefore, what you owe the financier is more than the car’s resale value. If you were to suffer any loss on the vehicle, you would still have a debt to pay yet have no car. In light of this, drivers must ask themselves, “how does gap insurance work?” to identify how it can best help protect them from such risk.
Amistad Insurance is a multi-line insurance agency with experience in protecting you from unnecessary risk. Talk to us to find out how gap insurance can help you avoid any unintended debt.