Do You Really Need Gap Insurance?

Buying or leasing a new car can put a big dent in your wallet, especially when you add in all the taxes and fees that go along with a new set of wheels. So it’s easy to be skeptical when someone tries to sell you additional insurance on top of your regular coverage.

“Guaranteed auto protection,” better known as gap insurance, is a specialized indemnity product geared toward drivers who would have trouble paying off their auto loan if the car was totaled or stolen. For some drivers, having an extra security blanket for their credit is probably worth the expense.  

When you get into a major wreck, your liability coverage doesn’t pay the cost of a brand-new vehicle. Instead, you’ll get a check for what a comparable car would go for on the used-car market. Insurers call this the vehicle’s actual cash value. The problem is cars depreciate quickly during their first couple of years, so it’s actually fairly easy to owe the lender more than the car is worth early on, especially if you put little or no money down when you bought it. In fact, the average automobile loses nearly a third of its value after just two years of driving.

Gap insurance helps take care of the shortfall. Suppose you bought a $30,000 car and it is stolen two years later. Because depreciation is most severe during those first couple years, the car is now worth only $21,000 on the market, yet you still owe the lender $24,000. If you have gap coverage, the carrier will kick in $3,000 to cover the difference.

Gap insurance is a niche product, and some drivers may be able to skip it altogether. If you bought the car with cash, gap insurance useless. And if you provided a substantial down payment at the dealership, there’s a relatively small chance you will end up upside-down on your loan.

Purchasing gap insurance makes the most sense if:

• Your loan payoff period is five years or more
• You’re leasing the car
• Your particular vehicle has a history of depreciating quickly
• You put a relatively high number of miles on the odometer each year
• You put down less than 20% when you bought the vehicle

Even if you have a small amount of negative equity, gap insurance isn’t a no-brainer. If you have the resources to pay the deficit out-of-pocket, you might be better off just taking your chances. Gap coverage, like other forms of insurance, makes the most sense for those who wouldn’t be able to handle a worst-case scenario otherwise.

Gap insurance is often built into car leases, so it’s a good idea to check the contract before getting coverage on your own. Otherwise, you may end up paying a premium for protection you already have.

There’s a good chance the dealer will try to sell you on their own gap coverage before you drive off the lot. However, they often charge substantially more than major insurance companies, so it pays to be patient and shop around a bit.  

On average, a dealership will charge you a flat rate of $500 to $700 for a policy. By contrast, a major insurer will typically price it at 5% to 6% of your collision and comprehensive premiums. So if you pay $1,000 a year for both those coverage options, you’ll only have to kick in $50 to $60 extra to protect your loan.

One of the other advantages of going with a big-name carrier is you can usually drop the coverage once you start to build equity in the vehicle. It doesn’t hurt to check with NADA or Kelley Blue Book to get an idea of how much your car is really worth and compare it to your loan balance.

Gap insurance can be a useful product, but only for those with significant negative equity in their car. That includes drivers who put little money down or have a protracted loan payoff period. (For more information, see: Get Up To Speed On Car Gap Insurance.)