Why Purchase Gap Insurance?
By: Linda Caswell, Capstone Brokerage Account Manager, March 2014
When you go to buy a new car many things may come up; extended warranties, road side assistance, gap insurance… Many Americans just say, “OK” to it all because car salesmen can be pretty persuasive. While extended warranties and road side assistance really are personal preference based on an individual’s needs, gap insurance can be an absolute necessity. Many car buyers require loans. At some point during the duration of the loan the cars value may be less than what is actually owed.
Gap insurance insures the difference between your car’s current value and how much you still owe on the car. This is especially important if you go into a car loan with a high interest rate or if you roll in negative equity from a prior car loan. Negative equity is when the value of an asset used to secure a loan is less than the outstanding balance on the loan. For example, you owe $25,000 on a car that is only currently worth $20,000. That would mean you are carrying $5,000 in negative equity. This is very common on cars that are brand new or recently purchased with high interest rates because cars depreciate so quickly. So even though you may keep your car until it is paid off and eventually own the car out right there may be a point where the cars value is far less than the loan amount.
So I have negative equity in my car. What is the big deal? Using the same values above, if you get into a car accident that totals the car, your automobile insurance will pay off the current value of the car based on blue book. So what about the $5,000 that you still owe on your loan? Well, unless you have gap insurance this has to come out of pocket. If you have gap insurance, it would pay the difference between what you owe and the book value of the car. In this case, the $5,000 difference from what is owed and what the cars blue book value is. With a deductible and the need for a new vehicle most Americans can’t afford $5,000 out of pocket so having Gap Insurance can really help them.
One situation where you ALWAYS need gap Insurance is a lease… Lease payments are much lower, resulting in a larger gap. The nature of a lease and the low payments mean there will always be a gap on the vehicle.
There are several factors that can help determine the need for Gap insurance. The length of the loan, the amount you put down, and how much you drive are huge. The best advice is to put money down on a vehicle (20% is a good rule of thumb), finance for no more than 5 years or pay cash. Also, know that on average anything over 15,000 miles a year is a lot and further depreciates a vehicle.
Although Gap Insurance is not expensive, on average 5-10 dollars a month, it is still smart to shop around. An insurance broker can help you find the best price for your individual needs. If you buy gap coverage from the auto dealer or the leasing company, you’ll likely pay more for coverage than you would from an insurance carrier. The trick is they put the cost into your loan causing you to be charged interest on the policy. So to save a few extra bucks have your broker go over your individual needs and help you obtain Gap Insurance if necessary.
