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Understanding Car Gap Insurance And How Not Having It Can Hurt You

Posted by Hank Coleman on Feb 24, 2011

According to a 2009 JD Power and Associate study, as many as 6 million car owners may be upside down in their cars. The study suggests that car owners are postponing buying a new vehicle because they cannot get out of the loans that they have on their current cars. One of the biggest problems is that many car owners find themselves upside down on their loans as soon as they drive their new car off the car lot. This creates an insurance problem and the need for car gap insurance because most car insurance policies only cover actual value and not the value that you bought the car for. So, in theory, if you total your car in an accident immediately after getting out of the car dealership’s parking lot after signing all that loan paperwork, you could find yourself having to pay out of pocket to close out your auto loan after your insurance company only pays for the car’s true value including depreciation. This is where car gap insurance comes into play.

What Is Car Gap Insurance?

Car gap insurance protects car owners who are upside down in their car loans. If you owe more money on your car than it is currently worth, then you need to have some type of savings built up to pay off that difference should your car become totaled or you need car gap insurance. Car gap insurance provides car owners with that difference between their car loan’s value and what the car insurance company will pay if your car is destroy, an amount that is the gap in your coverage, hence the name car gap insurance. This insurance covers the gap in car insurance ironically enough.

Why You Need Car Gap Insurance?

If you do not have car gap insurance and find yourself in a bad car accident, you could be held liable to pay the remaining balance on your car loan. This has the potential to cost a borrower thousands early in the first couple of years of their loans when the depreciation has been severe on their car note and when the loan balance is still high. For example, if you purchase a $25,000 new car, it has the potential of depreciating 20% or more as soon as you drive it off the lot. So, your new car may only actually be worth $20,000 in value. If that car is destroyed and the insurance company pays you its value of $20,000, the borrower still owes the bank the remaining $5,000 on the loan balance. While $5,000 may not seem like a lot, it has the potential to be a budget buster. There is nothing more demoralizing than paying for a loan on a car that you no longer own or is no longer even in existence after it was destroyed in an accident.

What To Do If You Cannot Buy Car Gap Insurance?

If for some reason you cannot purchase car gap insurance from an insurance company, you may want to consider self-insuring yourself against the loss. You should begin stockpiling money a little at a time until you have the equivalent of the gap between your car’s value and your loan balance. This will also give you options should you need to or want to sell your car before you finish paying off your loan balance. In order to sell your car, you need to have a free and clear title that will not happen until you are through with your loan payments. Until then, no one will be able to purchase your car from you with a clean title.

The gap comes from a car that has depreciated faster than you have repaid your car loan. The problem happens when something happens to your car requiring an insurance payout. The car insurance company does not care for the most part how much you owe on your car loan. Instead, they will payout only the value of the car in most cases. Car gap insurance prevents you from having to find money out of your own pocket should your car be totaled and valued by the car insurance company at less than what you owe your lender. Not having car gap insurance can cost you thousands of dollars.

Photo Credit – Flickr: jwthompson2