What is Gap Insurance?
Insurance is a word that is never far away from any discussion of automotive matters. It’s something that we know we are legally bound to purchase for our vehicles. It’s also something for which we now have a wide and varied marketplace of providers and types. Coverage is almost as varied as the vehicle choices that there are to be covered. Data published on Statista from 2019 showed that there were over 276 million registered vehicles on the roads in the US. Assuming not quite every vehicle has its own policy, with some shared across a single policy, it’s still 200+ million insurance policies that exist.
There’s one type of insurance, however, that continues to mystify a lot of car users. They look for the best car deals, buy and insure one, but then they hear about this mysterious insurance called “Gap Insurance.” This will be the focus of today’s article, but first, let’s get some background on vehicle insurance as an industry in the US:
The Insurance Industry – Some Important Figures
Numbers from the past decade sourced from IBISWorld, the National Association of Insurance Commissioners and the Insurance Research Council show a number of interesting things about the state of car insurance in the US. Among the two most recent and relevant figures are:
- $285 billion
What do these two numbers represent? The first is the amount of revenue that IBISWorld predicts was generated by the entire auto industry in 2019, the year before COVID-19 struck. The second number, according to the National Association of Insurance Commissioners, is the average annual cost of auto insurance in the US.
The Insurance Research Council came up with a statistic of 13 percent in 2015, (or one in eight), which represented the number of all US drivers who were uninsured. Some of these may have been residents of New Hampshire or Virginia, where car insurance is not required — though “financial responsibility to operate a vehicle” is required. Even in those states, most opt to show that responsibility through insurance.
What Does Typical Car Insurance Cover?
Above, we mentioned the richness and diversity of choice that consumers have when it comes to insurance. Major provider Allstate identify six main types of coverage available on car insurance policies. They are as follows:
- Liability Coverage – This is typically the minimum requirement in most states, and covers bodily injury liability and property damage liability. In other words, it covers the costs of the damage you do to others.
- Uninsured and Underinsured Motorist Coverage – Covers you in the event that you are hit by an uninsured driver who therefore would have no liability coverage to protect you and compensate for injuries to your self or damage to your car.
- Comprehensive Coverage – Covers your own car from theft, fire, hail, vandalism and more. It will help pay for any needed repairs if the car is damage by any of the things so nominated in the policy.
- Collision Coverage – Protects and covers your car from damage caused by collision with another vehicle or other obstacle like a fence or wall.
- Medical Payments Coverage – Covers the cost of your medical expenses, as well as those of family members and passengers who are injured while driving or riding in the insured vehicle.
- Personal Injury Protection (PIP) – Not available in every state. It covers not only medical expenses, but some other related costs that can be incurred as a result of your injury such as child care.
These six coverage types are ones that most drivers are at least somewhat familiar with having dealt with purchasing insurance for themselves at some point in the past. You’ll notice that Gap Insurance is not mentioned among them, and that’s because up to this point it remains somewhat niche.
What is Gap Insurance?
Gap Insurance is an optional coverage that is especially designed to help those who drive a car currently being paid for under a finance agreement. What is does is to help pay off the remainder of your auto loan in the event that your car is written off or stolen when the amount you still owe is greater than that of the depreciated value.
As purchasing a car on finance has steadily become the mainstream option for many car buyers, the number of cars on the road that drivers don’t technically “own” has also naturally increased. Credit rating agency, Experian, released data for Quarter 1, 2019 that revealed of all the new passenger vehicles on the road, 85.4 percent of them are financed either by an auto loan or a lease agreement. The number was 55.5 percent for used car purchases. This data carries forward into 2020, too, with Statista data showing the number for new cars held around 85.5 percent in the second quarter of 2020.
Therefore, Gap Insurance, or Gap Coverage, is a useful tool to avoid having to pay additional fees on a car you can no longer use. The sheer number of finance agreements and lease agreements mean the likelihood of needing Gap Coverage has gone up in recent years.
How Does Gap Insurance Work?
Here’s a simple example of how it works. Let’s say you bought a car valued at $30,000. As you know, that value depreciates as soon as you turn the key and drive it off the dealership lot. The total depreciation in the first year is especially high, and often is in the second year too. Let’s say that sometime in your second year of ownership, the car is totaled and you can no longer use it. What happens next?
First of all, your comprehensive and collision insurance kick in and pay for the repairs needed, or the cost of replacing the vehicle. However, these insurance types typically only cover up to the depreciated value of the vehicle. In our example, let’s say the depreciated value of the car is now $20,000, but you still owe $22,000 in repayments. Your main insurance policy would only pay $20,000, so what about the remaining $2,000. Ordinarily, the finance company would demand that you pay this, unless you have Gap Insurance.
Your Gap Coverage breaches the “gap” between the depreciated value and the amount you still owe in repayments. It’s typically a small amount in total, but is extremely useful in helping you to avoid additional costs after what is typically a traumatic event that renders your car no longer usable.
Do you Need Gap Insurance?
There is some disagreement about whether drivers should or shouldn’t get gap insurance. Let’s look at the principal arguments on each side:
Why Gap Insurance is Important:
Proponents of Gap Coverage point out that given the high rate of depreciation on new cars — averaging about 20 percent in the first year — there is a better-than-odds chance of drivers with auto loans going “underwater” on their finance agreement. What this means is that the amount still owed on the vehicle is more than that of the depreciated value of the vehicle over time. This is especially true on electric vehicles, where depreciation is extremely high, and also on high-end luxury vehicles, where 20 percent represents a larger chunk of cash.
Another situation in which gap insurance is important is if you’re loan deal involved a small downpayment with lower monthly payments over a longer time period such as 60 months. These factors make it even more likely that your payments won’t keep up with depreciation, which in turn increases the chances of you finding gap insurance useful in the event that the car is stolen or written off.
When Gap Insurance is Less Important:
If you have made a large downpayment on your vehicle, such as twenty percent or more, then you have likely already paid the cost of depreciation at least in the first year. On top of that, if your loan period is shorter, such as 36 months, then each month you are paying more and getting to the completion date faster. This situation renders Gap Insurance much less necessary.
Overall: Is Gap Insurance Worth It?
On balance, it’s fair to say that Gap Coverage is a useful addition to your insurance policy. Even for those who on the surface don’t appear to be a good fit, the type of car they purchase can still benefit from the added protection of Gap Insurance. It’s also a very suitable coverage for those who are leasing cars, which remains a very popular method of acquiring a new car.
In the end, you have to ask yourself, when you take the depreciate value of the car and the amount you could still potentially owe at any point, could you afford to pay the difference? Could you cover the gap? For many, the answer would likely be not, or at least it would mean a great financial strain. Therefore, Gap Coverage is beneficial to them.
How Much is Gap Insurance?
So, let’s say you have opted in and decided to get Gap Coverage on your financed or leased car. We think it was a smart move on your part, but the next question is how much will it cost?
Some people erroneously believe that the only people selling Gap Insurance are the dealerships themselves, and possibly banks. They do indeed sell Gap Coverage, but it will always be more expensive than other sources. You can pay as much as $700 for your Gap Insurance as a single lump sum. Spread over a few years you might think it’s not so bad, but compared to dedicated car insurance provider rates, it’s high.
Car insurance companies charge as little as $5 per month — $60 per annum — for Gap Coverage. Even if you paid that for a full 60-month term, that still would only reach $300, less than half of the lump sum you’d be paying a bank or dealership. For most loans of 36 or 48 months, it’s even better value.
Why is there such a disparity in price? The main reason is a premium on convenience. The dealerships charge more because as with many things at a dealership, you are paying a premium based on the one-stop-shop factor. The model relies on many buyers not being willing to shop around and instead getting all of their car finance and insurance purchased all in one place. While that does save time and effort, it inevitably costs more.
Buying Gap Insurance: A Quick Guide
Now that you understand the cost, it follows that you should also know, therefore, how and where to get the best deals on Gap Coverage. While it certainly the most convenient option, as we mention above, you do not have to purchase Gap Insurance from dealerships or from banks. If you want to save money, we suggest looking at insurance comparison websites and exploring your options via different car insurers. They will invariably charge much less.
Next, it’s crucial that you know when to buy your Gap Coverage. Can you buy it any time? Dealerships often claim you must purchase it before you drive the car away. Is that true, or just another marketing bully tactic?
The fact is that some insurers do require your vehicle to be brand new if you want to purchase Gap Insurance with it. This is presumably to avoid potential fraud, especially when it comes to used cars being sold at inflated prices, totaled and then Gap Coverage coming in to bridge an artificially enlarged gap. The two main requirements for Gap Insurance are:
- That you are the original owner; that you have the original lease or loan agreement on the vehicle and it hasn’t been passed on to anyone else.
- The vehicle is maximum 3 model years old, or newer.
Buyers should check the exact conditions stipulated by the dealership, leasing company or car insurance company when it comes to eligibility for Gap Coverage. While it’s not true that it’s legally required to be purchased before you leave the lot, some individual locations may well carry that requirement.
Conclusion: Should Gap Insurance Become Non-Optional?
As it stands, Gap Coverage is currently optional. No state requires drivers to have this kind of insurance. The question then is whether or not people should be made to buy it. Given the cheap cars for sale are nearly always bought on finance or lease agreements nowadays, Gap Insurance is a good product to ensure that both buyer and seller are better protected from future events. Neither party loses out.
Here at CarBevy, we are helping our users to get the best car deals available. With the money you save using a service like CarBevy, it might be a good idea to look into Gap Coverage either from the local car dealership you ultimately work with through us, or via a separate car insurance provider. It’s a useful protection to hold when you’re going to buy new car on finance or lease agreement, which is why we recommend you look into it.