Hummer Rear View
New cars deprecate and soon lose value. This is where GAP insurance kicks in.

Typically the first item on your list after buying a car is to contact your insurance company and make sure the vehicle is covered before driving away. You might have a sense of protection and peace of mind, but it might not be enough protection.

Physical Damage coverage includes Collision and Comprehensive (or Other Than Collision), which covers most of what could happen to your car if it is damaged and you need it fixed. All you have to worry about is coming up with the deductible and perhaps some money to replace tires if you don’t have brand-new tires (your insurance only pays the current value minus wear and tear).

But what happens if your car is stolen and never retrieved or it is totaled in an accident?

When you have a vehicle that is a total loss, either by accident or theft, the insurance policy only covers up to the book value, or actual cash value, of the car. Most claim adjusters use NADA or KBB to determine the value of the car.

When you have a loan balance on the car, your loan institution is listed as “Loss Payee” on your auto insurance policy. This means that the claims payment goes to them first. If there is any left over, you receive the balance from your loan company.

Unfortunately, if the current book value is less than the loan balance, they take the entire check and you have to pay the rest of the loan, even if you have to go out and get another car. Some people get trapped into this bad cycle of owing more and more money with less and less car. They might be tempted to go to a “specialty” auto dealer that can “pay off” your previous loan, which often means you are just paying much more for your new loan. Your interest rates might increase and you are left in another position of owing much more than the car is worth, setting yourself up for another payment gap.

Gap Insurance – How Does it Work?

This is where Gap Insurance (derived either from Guaranteed Auto Protection or Guaranteed Asset Protection) plugs in the “donut hole” of Loan Balance minus Claims Payout. The Gap Insurance will pay off the balance between the two so that you can start out from scratch without owing money on a car you no longer have.

Gap Insurance is provided in three ways:

  • Through the dealership
  • With auto insurance
  • From an independent third-party company

Before deciding on which Gap Insurance coverage will provide you the best coverage at the best rate, it is wise to shop around just like you would for the best car insurance premium. In some cases there might be a better deal through the dealership or third-party independent company, but often the auto insurance companies that offer it along with your regular auto insurance provide a pretty solid deal when combining it with your other coverages.

Before making a final decision, make sure you understand all the terms and conditions.

  • Is there a deductible?
  • How long can I retain coverage?
  • Do I have to renew?
  • Does the price change?

Some Gap Insurance policies will only cover a new car for the first couple years. Other policies might require higher payments the older the vehicle becomes, even if the gap between loan balance and value diminish.

By doing your homework before you are ready to sign away your life for your new car, take 30 minutes to check out a few Gap Insurance coverage options so you can make an informed choice and be confident of your protection.

Image: Flickr.