Is Gap Insurance Worth It?

When I was 18 years old, I bought a car—a very reasonable, dependable $7,000 Buick Century. While this could have been the start of a lovely story, it quickly became a nightmare: A few months after buying it, I got hit by a drunk driver who was speeding in a residential neighborhood. The insurance company declared the car totaled, but I wasn't too worried. I had car insurance, after all.

Well, as it turns out, car insurance wasn't enough. You see, traditional car insurance will pay up to the actual cash value (ACV) of the car, rather than the total loan amount. Since my loan was higher than the value of my car, I was left on the hook for around $1,500 that I simply didn't have.

This is exactly where gap insurance would have come in—if I had gotten it. And moments like this are what makes gap insurance most certainly worth it for most people, most of the time.

What is gap insurance?

When you buy a car and finance it, rather than paying for it outright, the car is technically owned by the bank. In typical times, new cars have a significant drop in value when you drive them off the lot. But used cars do, too—especially used cars you buy from a dealership where a markup often causes the loan to exceed the resale value of the car.

Now, normally this wouldn't be devastating, but if you happen to total your car or your car gets stolen before you have equity in the car, you may wind up upside-down on the loan. That means you'll own more money on the car than your insurance company deems it worth. Your car insurance company is only obligated to pay the ACV (actual cash value) of the car at the time of the accident. This takes into account how much similar vehicles are selling for in your area, the condition of the car insurance, interior and exterior damage, current necessary repairs, and other factors.

Gap insurance is designed to cover that gap between the value of your car and the balance of your car loan. If you don't have gap insurance, you'd be on the hook for that balance, which would come due immediately, since your loan no longer has collateral. Gap insurance and lease or loan payoff insurance can sometimes be used interchangeably, and while they may be effectively the same, sometimes they may not be.

Who Should Get Gap Insurance

Since gap insurance covers the gap between the value of your vehicle and what you own, anyone who might have that gap should consider getting the coverage. This includes anyone who:

• takes out a car loan for more than five years
• puts little to no money down on a car loan
• buys a car with a high level of rapid depreciation
• is not in a financial position to cover the gap between the loan and the value of the car

While gap insurance is superbly helpful for some people, it's not a necessary investment for others: anyone who makes a down payment of 20 percent or more on most cars (the exception to this is high-end luxury vehicles, which depreciate faster than most cars), people who are financially capable of paying the difference without much strain, and those who buy a car for cash.

Where to Buy Gap Coverage

Gap insurance is actually really affordable! How affordable depends on where you buy your gap insurance.

You can buy coverage from:

• Your car insurance company
• The dealership you are buying your car from
• The bank or credit union that finances your loan

While coverage is often similar, prices from gap insurance vary dramatically depending on where you buy it from, the ACV of the car, the age of the vehicle, and your insurance claim history (when buying from an insurance company). Most often, buying gap insurance from the dealership you're buying your car from is the most expensive place to buy it.

On the flip side, your insurance company will offer you the best rate for gap insurance, usually starting at around $30 or more per year. Unfortunately, not every insurance company offers coverage. If you are leasing your car, some lease contracts already include gap insurance or require you to buy a specific gap insurance product from them.

Be sure to read the details of the gap insurance coverage. Some cap the payout number to a certain percentage of the value of the car or have other stipulations.