How Does Gap Insurance Work?
quick highlights
Gap Insurance covers you while you owe more than the car is worth.
Buy Gap Insurance from your car insurance company, not the dealership.
Gap Insurance is usually not too expensive.
Gap Insurance pays if your new car is wrecked (totaled) or stolen right after you buy it and you still owe the bank more than it's worth.
It helps cover the “gap” between the amount owed and the amount the insurance company would offer as a settlement.
The “gap” is also the time period between the date of purchase and the day you pay down the loan enough to owe less than its worth.
So, 'How does gap insurance work?'
Remember, brand new cars lose a ton of their value as soon as you drive them off the lot.
This is known as “depreciation”.
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If you were buying a home that was worth less than you owed on it, you would be “underwater” or “upside down” on your home loan.
This is very common in the world of new car owners because most people finance most of what they owe on a new car when they buy it.
As soon as you drive the new car off the lot, it loses 20-30% of its value.
If you have a loan or a lease, you might be forced to buy Gap Insurance by the lender.
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How Much Does Gap Insurance Cost?
It's usually not that expensive. Maybe $14 a month.
You just tell your car insurance company you need to add it and they can tag it right on to the existing policy.
If you can afford a brand new car, you can probably afford Gap coverage.
If you can’t, you might need to consider a used car.
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Depreciated value:
The amount of money the insurance company is going to pay you to replace your totaled or stolen car. If you owe more than it's worth, your lender won’t be happy because they don’t have the asset to back up their loan anymore. You won’t be happy because you still have to make payments on a loan for a car that is gone.
When You Don't Need Gap Insurance
If you can make a big down payment on your new car, you can probably avoid gap insurance.
The concept of Gap Insurance exists to help people who are upside down on their car loan.
So if you can walk into a dealership and drop $20,000 as your down payment on a $60,000 car, you are immediately in the clear.
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How Does Gap Insurance Work?
Get Gap Insurance until you’ve paid down the new loan to the point that you owe less than its worth.
If you buy a new car and finance a large part of the total price, you definitely need Gap coverage.
Consider This Story...
Chris just bought a brand new Nissan Armada for $60,000.
He makes tons of dough, so he dropped a $30,000 down payment.
His wife loves the leather interior.
So he drives the Armada home and it immediately loses 20% of its value.
That makes it worth $48,000.
But he only owes $30,000 on it, so he isn’t upside down on the loan.
So it would be up to him whether or not he buys the gap coverage. The lender won’t say a word.
So Let's Look At This Example:
Joe just bought a brand new 2021 Jeep Grand Cherokee L model for. It was $55,000.
His down payment was $5,000.
He now owes $840 a month for the next five years.
The thing is only worth $44,000 when its stolen six days after he bought it.
Why? Because it depreciated 20% as soon as he drove it off the lot.
So now, he can’t afford to replace his Jeep because its value was $44,000 and he owed $50,000.
This is why your lender is going to force you to buy Gap Insurance if you don’t put much money as a down payment.
They have a financial interest in that Jeep until it’s paid off.
They really worry until you get that loan paid down below its depreciated value.
And so should you.
Where to Buy Gap Insurance
The car dealership is probably going to offer it to you.
But they probably won't tell you how Gap insurance works.
If I was buying a new car, I’d just add it to my car insurance policy.
Why?
Because if your car is stolen or wrecked, you are going to be dealing with a insurance claim.
Insurance claims take time to settle. This is annoying because you just want your money, but the claims adjuster has to do his “diligence”.
Action Item: Make sure to get proof of Gap Insurance to your lender, so they will be happy and stop bothering you.
If you buy your Gap Insurance from the dealership and your regular comprehensive and collision insurance from your car insurance company, you are going to slow down this process.
By going through your car dealership for the Gap Insurance and your car insurance company for the other coverage, you are giving yourself two claims to settle and two claims adjusters to deal with.
Why would you do that to yourself? You’re just slowing down the process and making it more complex.
Easy answer: go with the car insurance company for all the coverage.
don't be a dodo!
Watch out for this mistake!
By forgetting to find out how much the insurance is going to cost if you trade in your old car for a new one. Knowing the “total cost of ownership” before you buy is important.
In Closing: How Does Gap Insurance Work?
If you put down less than 10% of your car’s purchase price, your lender is going to force Gap Insurance upon you.
The lender wants the collateral on his loan insured correctly and until he no longer has a financial interest in the car, the bank can dictate insurance terms to you.
Shopping around for insurance quotes before you buy a new car is easy and a smart thing to do.
Plan ahead and you will know the total cost of ownership before you drive off the lot with your sweet new ride.
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