Buying a new car can be difficult in many ways. Hopefully, once you’ve made a deal, you’ve done a thorough study of the best model and model for you, you know how much you have to pay and get a lot of benefits, you’ve figured out and overcome the tricks car dealers use to separate you from money hard cash, and you’ve got financing for your vehicle at a hefty interest rate.
But another tough thing you have to deal with is insurance. We all think we understand what vehicle insurance is. If you have an accident and your car breaks down, you will fix it, and insurance pays for it. If your car is summed up or stolen, you get paid for the value of the car, and you get the rest. There are some wrinkles, like deductibles, but otherwise, it’s pretty simple. Right?
Not so fast. There are many other “wrinkles” that are not so mild and, if they appear, can cause you major headaches. Gap insurance can help, but is it worth it?
What is the Insurance Gap?
Of course, it’s impossible to know if buying gap insurance is worth it if you don’t know what it is, so here’s a brief explanation. We’ve all heard the expression, “a new car will lose half of its value when you remove it from the lot.” Now, that’s not true, but its value drops significantly in a very short time after purchase, and every new vehicle loses a lot of value in the first year. No matter how old your car was when you bought it, I can guarantee that unless it’s a classic car or you’ve poured your heart (and repair money) into it, it will be worth less than you paid in a few years. That’s depreciation for you.
Let’s say you take out an auto loan, buy a new car and take it out of the lot. It quickly depreciates so the resale value is now a little more than you paid for a few thousand dollars. A month after purchase, another driver hits your new car and makes it whole. Insurance will give you the current actual cash value (ACV) of the vehicle which, as we said, is several thousand dollars lower than the debt you paid. How would you tell the difference? That’s where gap insurance comes in. Gap insurance pays to policyholders the difference between the ACV and the amount owed on the loan.
Why Doesn’t Everyone Have Gap Insurance?
Not everyone whose car is stolen or its volume needs gap insurance. It can only benefit owners who are financing the purchase of their new car and only for periods when their car is worth less than what they paid on the loan. This is known as the “reverse” on the loan. The period can be quite short or surprisingly long depending on one or more of the following factors:
- Make, and model of car purchased: All new cars shrink significantly in the first few months after purchase, but some shrink faster than others.
- Long-term loans: When you take out an auto loan for more than 36 months, your monthly loan payments will be lower, but you will pay more in the long run, and there will be a longer period when your car’s ACV will be less than what you owe a loan.
- Lower little or no money, and borrow more than the purchase price: The more debt you take in advance, the longer the “gap” will be.
How Much Does Gap Insurance Cost and Is It Worth It?
One thing most people don’t want to hear is that it adds to the cost of buying a new car voluntarily by showing that an optional form of insurance is a good thing to buy. Fortunately, gap insurance is cheap enough. Common gap insurance premiums are calculated based on the collision and comprehensive coverage premiums in the policy and have about five to six percent of those costs.
Remember two more things. First, as your vehicle shrinks, the cost of your comprehensive and collision coverage will decrease, as will the cost of your gap coverage. And second, once you reach a point where you no longer owe your vehicle more than its current ACV, you will no longer need gap coverage and you can cancel it.
Before you buy gap insurance, it is necessary to do calculations to find out how much gap insurance will benefit you. If your loan is a little upside down, it may make more sense to save in a savings account for the possibility that you will eventually need “gap insurance”. If you go through this road, worst-case scenario, you play with the money you have spent, and best-case scenario, nothing happens to your vehicle and you can save that money.
Why is Gap Insurance So Cheap?
Gap coverage is very cheap because very few claims are made against the gap policy, and that lowers the cost of premiums for you and others.
Gap insurance, unlike regular insurance, only covers a very specific amount of money (the amount of your loan minus the amount of money your car is worth) for a very specific period (until the equation is zero or negative).
So is gap insurance worth it? That’s for you to decide. But if you’re buying a new car and don’t have a lot of extra money while your loan is upside down, you should seriously consider gap insurance.