Gap Insurance: What is It and Who Needs It?

Gap insurance, also known as “loan/lease coverage” or “loan/lease payoff coverage”, is a type of automobile insurance coverage that protects you if your car is totaled while you are upside down on your car payments. It supplements your collision and comprehensive coverages by paying up to a certain percentage (often 25%) more than your car’s fair market value in the event your car is totaled and you owe more on it than it is worth. If your car is paid off, or if it is worth more than what you owe on it, you don’t need gap coverage. Otherwise, you do. The good news is that it is a fairly cheap coverage.

How Gap Coverage Works

Gap coverage is only triggered if the damage to your car results in a total loss. It applies whether the damage to your car is your own fault or someone else’s. To understand the value of gap coverage, you must understand how automobile property damage coverages work. Your collision and comprehensive coverages will only pay you the fair market value of your car if it is totaled. So, if you owe $10,000.00 on your car, but its fair market value is only $8,000.00, collision or comprehensive coverage will only pay you $8,000.00 (minus any deductible) if the car is totaled. You are still responsible for the remaining $2,000.00 you owe on the car loan.

Gap insurance pays that $2,000.00 gap between the value of the car and how much you owe. Some gap coverages will even pay your collision or comprehensive deductible. This will depend on your specific policy language.

Gap coverage is often capped at a certain percentage above your car’s fair market value, such as 25%. In the above example, this works out well, because $2,000.00 is 25% of $8,000.00. However, if you owed $11,000.00 on that same car, you’d still owe $1,000.00 even after your gap coverage paid (which is still better than owing $3,000.00). Just be aware of whether your gap coverage cap is sufficient to fully protect you. Note that gap insurance will never pay more than the amount required to pay off your car loan, regardless of the percentage cap.

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What if Someone Else Damages My Car?

If another driver totals your car, his property damage coverage will only pay you the fair market value of your car, regardless of how much you owe on it. This may seem unfair, as ultimately his negligence caused you to have to pay off your entire loan. However, the law only allows you to recover the actual damages caused by his negligence. In this case, he deprived you of a car worth a certain amount. The fact that you owed more than the car was worth is not his fault. You owed more than the car was worth before the accident ever happened.

Once again, gap coverage comes to the rescue in this situation. It will still pay off your car loan (up to any applicable cap) even though the damage was caused by a third party’s negligence.

How Do I Know if I Owe More Than My Car is Worth?

Figuring out the amount you owe on your car is straightforward. Multiply your monthly car payment by the number of payments remaining. Figuring out the fair market value for your car requires more research. Even experienced insurance adjusters can differ in their valuations of cars.

An excellent free online resource for estimating your car’s fair market value is Edmund’s True Market Value tool. It goes beyond a simple make, model and year valuation and customizes its value using factors such as mileage, color, options, condition and will even tailor it to your region if you enter your zip code. This is also a great tool to use if you handle your own property damage claim.

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When In Doubt, Get Gap Insurance

If you’re not sure whether you are upside down on your car payments, buy gap insurance. It’s better to be safe than sorry. It is extremely cheap compared to your other coverages (when I needed it many years ago, it was around $20-30 for a whole year). Losing your car in an accident sucks badly enough. Losing your car in an accident and still having to pay for that car sucks beyond imagining.

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