What Is Gap Coverage and Why Should I Have It?

Most people these days do not keep cars for long periods of time. With easy financing terms, many people choose to trade cars far more often than they used to, and many drivers are taking advantage of leasing options, which encourage “turning in” the vehicle every few years in exchange for a new one.

Because of this, the old type of insurance coverage which focused on “book value” may not be appropriate for the needs of modern automobile owners and leasers. Fortunately, there is a new type of coverage called “gap coverage” which takes care of the difference between actual value and appraised value.

Here is how gap coverage works. Suppose you buy a new car for $20,000. The first year you own the car, the greatest depreciation occurs, so by the end of the year the car you bought for $20,000 may only be worth $12,000. Now, suppose you financed the car and have only paid $2,000 on the principal. This means that the car valued at $12,000 actually has $18,000 still owing on it. The $6,000 difference would be your responsibility if the car was wrecked beyond repair.

Gap coverage solves this problem by paying the difference between what you owe and what the car is worth. In the above example, your gap coverage would pay the $6,000 difference, and you would not owe any money.

Gap coverage is a necessity if you finance a vehicle, at least for the first few years. If you trade in your car every three to five years, you should probably keep a gap coverage policy in effect at all times.

However, once the book value is the same or greater than what you owe, you can usually afford to drop your gap coverage. Gap coverage is usually written up as an addendum to your regular liability insurance policy.

This means that you will purchase a regular liability policy and add the gap coverage for an additional fee. In most cases, this additional fee is far less than you would pay in the difference between your vehicle’s value and what you owe. However, you should pay attention to the amount of your gap coverage addendum and be sure that your premiums are not more than the amount of coverage you will obtain.

Some car financers also offer gap coverage as part of your financing package. They do this so that they can be sure that you will be able to pay off the car if it is “totaled” or damaged so badly that repairing it would cost more than replacing it. Whether your financing package includes gap coverage is something you need to be sure of before you purchase a gap coverage policy.

There is another route you can take to replace your car if it is totaled. This is called “replacement coverage,” and is offered by some insurance companies. A form of “gap” insurance, replacement coverage guarantees that if your car is totaled, the company will pay to replace your vehicle with an identical model, whatever the year or value of your car.

Some people choose this coverage when they do not finance the vehicle, but want to be sure they will not suffer a loss if the vehicle is totaled by the insurance company estimating “book value” and paying only that amount.

You can discuss the advantages of gap coverage and replacement coverage with your agent, who can help you choose the appropriate form of coverage for your needs.