Understanding Gap Insurance

You’ve just signed the papers to take possession of the car you’ve dreamed of having since you were a kid drawing pictures of cars in your notebook when you should have been paying attention in math class. You’ve negotiated a terrific lease. The payment is affordable, you’ve more than enough miles in the contract to enjoy the car and the residual value is good too.

All is right with the world — until you get T-boned and the car is totaled. Your insurance company offers a settlement, but it isn’t enough to buy out your lease.

Here’s where understanding gap insurance comes in handy.


What Is Gap Insurance?

As the scenario above indicates, gap insurance covers the difference between what you owe and the depreciated value of a car should it be destroyed, stolen, or otherwise rendered unsuitable for use (considered a total loss). You might also see it referred to as loan/lease coverage or guaranteed asset protection. Said in the simplest terms possible; gap insurance helps you recover the difference between what you owe and the amount you’ll receive from your insurance company after a total loss.


When You Should Get Gap Insurance

Odds are a gap insurance policy will be of benefit to you if you find something you like after running an internet search to “lease a car near me,” or you finance the purchase of a new car. The best way to decide whether or not you really need it is to get an idea of the wholesale value of your car and compare it to the payoff amount of your loan or lease contract. If the latter is higher than the former — if you’ll owe more than the car is worth — gap insurance could be a good move for you.

In some cases, lenders and leasing companies will require you to have it as a condition of the contract. This is particularly true in situations in which you made a very low (or no) down payment, or agreed to an extended loan or lease term. Gap insurance can also be beneficial if you put a lot of miles on your cars or drive an expensive luxury or sports car.


How Gap Insurance Works

OK, so let’s say you lease a car worth $25,000. Your down payment and the payments you make up until the time of the accident come to $10,000. This means there’s another $15,000 in value out there the leasing company was expecting to derive from that vehicle.

Your insurance company values the car at $10,000 and cuts you a check for that amount. The leasing company thanks you, accepts the check graciously and asks, “Where’s our other $5,000?” In other words, you don’t just get to walk away because the car was totaled — they want the rest of their money. If you have gap insurance, the underwriter of that policy will fork over the outstanding balance.


What Gap Insurance Covers

As we’ve mentioned above, gap insurance can be a real benefit if your car’s totaled and the balance of the outstanding financial obligation is more than the depreciated value of the car. However, gap insurance can also kick in if the car is stolen and not recovered — or stolen and damaged so badly you can’t be expected to keep driving it.

On the other hand, gap insurance does not cover your deductible if the car can be repaired, nor will it help you if someone is injured in the accident in terms of covering their medical care, funeral expenses or missed paychecks.

Understanding gap insurance can help you avoid a huge out of pocket expense. But you do have to weigh the benefits against the costs to decide if it’s right for you.

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