Technically, the car still belongs to the manufacturer or leasing company. But, you're still responsible for replacing it. That's right. Even after your auto insurance company figures out how much the car is worth and pays off the damage, you may still owe the carmaker some dough. And that's where gap insurance comes in. Though it may sound trivial, gap insurance is a must for leasing. And if you made a small down payment when buying a car, a gap policy can be a lifesaver as well. But first, let's look at why it exists.
As the name implies, gap insurance covers what traditional car insurance doesn't. In other words, it closes the gap between what your auto insurance company pays if your car is stolen or totaled and what you owe the finance company.
Let's take a test case. Say you bought your car two months ago for $25,000. You begin making car payments at about $500 a month based on a 6-percent interest rate. Then, disaster strikes: a tree falls on your car and flattens it.
You call the auto insurance company and the adjustor looks into his crystal ball and decides at the time of the accident your car was worth only $20,000. The car may only be a couple of months old, but it has already lost 20 percent of its value. Unfortunately, the finance company still wants the full amount you owe them. With interest, tax and license fees, they figure that to be $27,000.
Yikes! There's a gap of $7,000 between the $20,000 that the insurance company is willing to pay you and the $27,000 the finance company is demanding. Most folks are going to be eating Spam dinners for the next two years, but if you have gap insurance you can safely order steak.
Apply the same scenario to someone who bought their car. If they left the dealer lot without putting several thousand dollars down, they likely owe more than the auto insurance company will pay if the vehicle gets totaled or stolen in the first few years. Once again, gap coverage can save the day.
And that's why gap insurance is a must for many drivers. In fact, gap insurance is usually mandated by lease contracts or included within them. If a gap policy is required but not included in your contract, you should shop around for this coverage (car insurance companies sell it). If gap coverage is included in the car lease, check to see how much is offered and how much you're going to be paying for it. (In some cases, lease contracts may include what is known as a gap waiver, which protects you from gap charges in the event that the leased vehicle is declared a total loss - eliminating the need for a gap policy.)
Is gap insurance necessary for people who finance their cars? Well, it depends on your coverage. If your regular auto insurance policy is written to pay off the fully financed amount, then you don't need gap insurance.
A few things to keep in mind when buying gap insurance:
- Although most people purchase it when a lease is initiated, some car insurance companies will sell you a gap policy anytime during the lease term.
- You must be in compliance with all terms of the lease.
- Your gap insurance policy may not be honored if you don't have collision and comprehensive insurance coverage. Further, lease contracts generally require that you carry collision and comprehensive at all times.
If your car is totaled or stolen, carefully follow all requirements made by your auto insurance company. For example, some companies require you to continue making car payments on your totaled vehicle until the money from the gap insurance is paid out.
So when initiating a car loan or lease, always remember to ask your insurance agent or loan officer about gap insurance. If you have an accident, you'll be glad you planned ahead.