Gap insurance, more accurately called gap protection, covers the difference between what you owe on your car and how much the car is worth. Not everyone needs gap insurance (also called "totaled insurance"), however. Do you? Learn the basics of gap protection: What it is, who needs it, and how to buy it.
For many drivers, a standard auto insurance policy provides enough protection to cover the cost of repairs or replacement if their car is damaged or stolen. However, if you total your car and the car's actual cash value is lower than the amount you owe on your loan balance or lease, that difference, or "gap," is not covered by insurance. Your insurance company won't pay out more than the car is worth (before it was damaged) -- so you will be responsible for paying that amount.
Gap protection -- which is often referred to as insurance, though it is actually a debt cancellation agreement -- is designed to cover this difference between auto value and auto loan. Before you pay for gap protection, though, consider how a gap occurs and how you can close it.
Negative equity -- when your car is worth less than what you owe on it -- puts car buyers and lessees at risk because an auto insurance policy won't pay out more for repairs or replacement than the auto is worth.
Here's an example of how negative equity happens:
|Auto loan (5 years @6%):||$25,000|
|Loan balance (after one year):||$20,580|
|Car's actual value at time of loss:||$19,000|
|Amount insurance company pays:||$18,500|
|Gap (loan balance -- insurance payment):||$2,080|
Often, borrowers find themselves "upside down" (owing more than the auto is worth) through a combination of factors, including:
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