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Gap Insurance What it is and why you need it

As soon as you drive off in your new car, its value starts to drop. It’s called

depreciation, and almost everything you own does it. Some things depreciate

very quickly: electronic equipment, clothing, and, of course, cars all top the list.

Because a car’s value drops sharply as soon as it’s no longer “new,” there’s

usually a period of time when you owe more money on a car loan than the car

is actually worth.

When this happens, your loan is “upside-down” and the car has what financial

folks call “negative equity.” Let’s look at a scenario when negative equity can

really put you in a bind.

Let’s say you’ve bought a new car for $15,000. Your down payment was $1,000, and your loan rate is 5.76%. That

means that your monthly payment will be about $424 a month for a term of 36 months. The total amount you owe on

your loan is $15,264.

Then, disaster strikes. Your car gets totaled. You call your insurance company and file a claim. But the insurance

company will only pay for the value of the car at the time of the accident. Because cars lose value so fast, after just a

few months, your car’s value will have dropped by 20%. So the insurance company gives you a check for $12,000.

But you still owe over $15,000 on your loan. There’s a big, fat $3,000 gap between what your car was worth and how

much you owe on it.

That’s exactly what Gap insurance is for: to make up the difference when something like this happens during a period

of negative equity.

Gap insurance is usually offered as an add-on at the dealership, but some auto insurance companies also offer it. As

far as your finances go, it’s a must. The cost is relatively low (because of the low odds that your car will be totaled

while your loan is “upside-down”), and the benefits far outweigh the investment. Search for gap insurance online, and

you can do some comparison shopping for yourself.

If you’ve leased your car instead of buying it, chances are that gap insurance is built into your lease agreement. Some

states, like New York, require it by law. But be sure to ask about it before you sign your lease. If it’s not included,

insist on adding it on. Even though you haven’t actually bought the car, you’ll still be held responsible for its full sticker

price value should it end up totaled.