Do You Really Need Gap Insurance?

Kat Tretina

October 23, 2017  •  4 Minute Read

Insurance

If you’ve ever bought a car at a dealership, you may have felt pressured to add gap insurance to your contract. For some people, gap insurance may be a good deal. But for others, it can be a complete waste of money.

The problem is that the dealer won’t tell you which group you’re in. Read on to find out what gap insurance is and how you can tell if you need it.

What is gap insurance?

A gap insurance policy covers the gap between how much your car is worth and how much you owe on your loan. If you get in a car accident and the insurance company deems the car totaled, your lender will get a check for the replacement value of the car.

If it’s not enough to pay off the loan, however, you’re still on the hook for the remainder. You could owe money on a car that you don’t even have. Gap insurance covers that amount.

Some lenders require gap insurance to protect themselves from default, but not all. If the dealer tells you that your particular lender requires it, call them directly to verify before signing the contract.

4 questions to find out if gap insurance is right

There’s no one-size-fits-all answer to whether gap insurance is right for you. If your lender requires it, you don’t have a choice unless you choose another lender. But if there is no requirement, ask yourself these four questions to find out if you need gap insurance:

1. How much will the gap be?

The gap between the car’s value and your loan amount depends on two things: whether the car is new or used, and how much of a down payment you have.

If you’re buying a new car, it can lose around 10 percent of value as soon as you drive off the lot, according to CarFax. By the end of the first year, it can lose another 10 percent.

If you put a sizeable amount of money down on the car, this might not be an issue. But if not, you could be in trouble if the car gets stolen or totaled.

For example, say the car is worth $30,000. Within a year, the replacement value could be only $24,000. If you only put $2,000 down and paid off another $2,000 of the loan over the first year, your gap is $2,000.

Used cars are more likely to retain their value in the short term, but it might be still worth considering gap insurance if you didn’t put any money down on the loan.

To find out how much the car is worth, use Kelley Blue Book or NADA. If you have a new car, knock 10 percent off the value since that’s what you’ll lose when you drive home. Then subtract the loan amount from the car’s value. If the resulting number is negative, you have your gap amount.

2. Can you cover the gap yourself?

Just because you have a gap doesn’t mean you need gap insurance. The chances that your car will be stolen or totaled are slim, so you may never have to pay up. If you buy gap insurance, however, you’re out that amount regardless of whether you need it.

After you’ve calculated your gap amount, determine whether you have enough of a cash cushion to cover it. If you do, you don’t need it.

Of course, you can still purchase gap insurance, even if you have enough cash to cover the risk. For some people, it may be worth the peace of mind. But still run the numbers so you can make an educated decision.

3. How much does the gap insurance cost?

Dealerships sell gap insurance for $400 to $600 on average, according to Edmunds, an online resource for all things automotive. Compare this with how much your dealer is charging to determine if the policy is overpriced.

Also, know that the cost of your policy will likely be more than what you see on your contract. That’s because most dealers roll it into your auto loan. If so, you’re essentially financing the policy premium and will pay interest on it over the full term of your loan.

Once you know the cost of your gap policy, compare it to the actual gap you might be facing. For example, if the policy costs $600 and your gap is $800, it’s likely not worth it. If it’s a small fraction of the gap, however, it might be worth buying.

4. What limitations are there?

Each gap insurance policy comes with limitations that could void the contract. For example, you could lose your coverage if you have overdue loan or lease payments. The insurance company could also refuse to cover any aftermarket equipment you add.

Make sure to read the fine print on the gap insurance policy before you sign.

Do your due diligence

For some, gap insurance can offer peace of mind and financial security. For others, it can be simply another add-on they don’t need.

It’s crucial that you do your research to find out if gap insurance is right for you. If you feel pressured by the car dealer, that’s all the more reason to run the numbers on your own.

Regardless of whether or not you choose to buy gap insurance, you’ll have peace of mind if your decision is an educated one.