Buying and financing a brand new car can be exciting. It can also be expensive. You will likely need to come up with a down payment. You’ll also have to register the car and buy insurance—not to mention start making those monthly payments.
Although you don’t want to think about any additional car costs, there is one more expense that might be worth considering: gap insurance.
What is gap insurance?
Gap coverage, also sometimes referred to as "guaranteed auto protection" is a specific type of insurance that covers the "gap" between what your insurance company will pay out for an accident or theft and the total amount you owe on your car loan.
So, say you bought a new car for $30,000, including taxes and fees, and you put $1,000 down. The moment you drive off the lot, your new car’s value will drop by an instant 11% and some say 15% is a more accurate figure. About a year later, you get in an accident and your car is totaled. You file a claim with your insurance provider and find out your car is valued at $22,000. Meanwhile, you owe $25,000 after a year’s worth of payments - leaving you with a $3,000 "gap."
If you have gap insurance, it will pay for the amount you still owe on your loan. Without the insurance, you’ll be stuck paying off a loan for a car you no longer have. Plus, you will now have to figure out how to come up with the funds to buy another car.
Should I get gap insurance?
Now that you know what gap insurance is, now it’s time to see if makes sense for you to buy this type of protection. Generally speaking, it’s a good idea if the following applies to you:
You owe more on your loan than your car is worth. Sometimes this is referred to as being upside-down on your loan. If you put less than 20% down on your new car and take out a loan for more than four years, you will commonly owe more on your car than its current value - at least for the first two years of your loan.
You won’t be able to afford to pay the "gap" between what you car is worth and what you owe the lender in the event your car is totaled or stolen.
You drive more than 15,000 miles per year. Driving an excessive amount means your car will depreciate in value more rapidly than similar cars not driven as much.
Your car depreciates faster than others. Some cars hold up their value better than others, so it would be worth researching the rate of depreciation of your car.
Your car typically ranks right up there with the most stolen cars in America. If you own a Honda Accord or Toyota Camry, your car usually tops the list.
Where do I get gap insurance and how much does it cost?
You can buy gap insurance through the auto dealership where you purchased your car, the lender that financed your loan, or through your car insurance company.
If you don't have time to spend on detailed insurance rate comparisons, start with your car insurance company. All things considered, going this route will typically cost you less than the other options, plus you can roll it into your premium. Gap insurance purchased through your auto insurer usually tacks on about 5% to your total comprehensive and collision bill. So, if you pay $700 a year for this coverage, your gap insurance will cost you an additional $35 a year.
Another benefit of purchasing gap coverage through your insurance company: It makes the claims process easier. No one wants to deal with insurance, that’s for sure. But, if you find yourself with a totaled or stolen car and have to make a claim, it’s much easier to deal with only one insurance company.
Photo credit: Penn State