If you’re headed out to take advantage of year-end new-vehicle clearance sales, or are just considering buying a new set of wheels in the coming weeks or months, it’s likely you’ll be offered any number of transaction add-ons before closing the deal. While experts advise shoppers decline most of them – like extended warranties, rustproofing and fabric protection – there is at least one that should be seriously considered, and that would be what’s known as “gap insurance.”
With new-car prices averaging around $10,000 more than they were five years ago, and financing terms extending to as long as six, even seven years to help salve the financial blow, nearly one in four vehicle owners are now “underwater” on their car loans, according to Edmunds.com.
Also referred to as being “upside down,” it means owing more money on a vehicle than it’s worth for insurance purposes. If a financed vehicle gets stolen or is totaled in a wreck, the insurance company will only reimburse the owner for what’s considered its actual cash value, and not what he or she paid for it. That means having to come up with a sizeable wad of money to the lender, and the situation only gets worse if the car was purchased with a minimal down payment, and/or has a quicker-than-average rate of depreciation.
Edmunds says the average amount owed on upside-down loans has swelled to an all-time high of $6,458.
That’s where gap insurance comes in. This type of policy covers the difference between what a given vehicle is worth and what the owner or lessee still owes on it, should it be stolen or become totaled in an accident. For the record, “gap” stands not for the above imparity, but for Guaranteed Auto Protection.
Obtaining it is a requirement in leasing contracts, and it’s become increasingly essential for those buying a vehicle, especially costlier models financed for extended periods. It also provides a buffer against the possibility of resale values crashing down the road.
Experts suggest motorists consider buying gap insurance if they’re making less than a 20 percent down payment, having rolled over a previous car loan balance into a subsequent purchase, and/or are financing a car, truck or SUV for 60 months or longer, especially at today’s higher interest rates.
Consider a model that cost $40,000 when new, but still has an outstanding loan balance of $32,000. If the owner gets into an wreck and the vehicle is declared a total loss with an actual cash value of $26,000 and a $1,000 deductible, the insurance company would offer a settlement of just $25,000. Gap insurance, however, would cover the outstanding $7,000 that would otherwise be owed to the financing company.
Gap insurance can be purchased from a new-car dealership or can be added to an existing auto insurance policy, though not all providers offer it in all states. Take note that costs and terms will vary from one company to another It usually costs only a few extra dollars per month when added to an existing insurance policy, or from $400 to $700 if sold by a dealership.
Some policies will also cover the comprehensive and collision deductible, while some insurers will bundle gap insurance as part of their extra-cost new-car replacement coverage. For those leasing a new vehicle, the leasing company or automaker’s financing division will typically build the cost into the agreement.
Gap insurance is essential for lessees because a new-vehicle lease is virtually unbreakable. Whether the car is totaled or the lessee can no longer afford it because of a loss of job or divorce, he or she is still liable for all scheduled payments. Here again, the difference between what the lessee still owes on the contract and the vehicle’s actual cash value can be substantial, especially if the automaker originally artificially inflated the car or truck’s end-lease value or granted a hefty cash rebate to help spur sales.
And, though it may not need to be said, those who own a car or truck free and clear don’t need gap insurance. Likewise with one that’s financed, but is worth more than is owed, either because of a hefty down payment or online valuation tools indicate a higher-than-expected resale value.