The simple explanation is that gap insurance closes the “gap” between what your insurance company believes the worth of your vehicle is and how much you owe the finance company.
With this knowledge it will be a simple matter to find out exactly how much gap insurance you will need.
The minute you drive a new car off the dealer’s lot it depreciates by 25%. If you purchase a vehicle for $32,000, as you leave the lot it devalues to a worth of approximately $24,000.
This means that if you were to turn around and immediately resell the new vehicle you may get around $19,000, if you’re lucky. After a year the car would be worth $20,000, and by the end of five years you would find it worth around $10,000.
Of course gap insurance isn’t needed if you’re one of those who pays cash, which is an exception. If you were to take out a finance loan of 0% down and 6% APR for 60 months then after one year you would end up paying approximately $3000 more than the car’s worth.
By the fifth year the gap would close, and you would have a car worth $22,000 less than when you purchased it. And this is if you have good credit in order to get financing at a 6% premium interest rate with 0% down.
Gap insurance fills in the “gap” between what you owe on your car and the devalued market price in case of an accident or other unforseen occurance. However, there are some cases where gap insurance will do you no good.
- For example, if you place a substantial downpayment, say 25%, on the new car and then take out a loan much less than the value, you have already taken care of most of the depreciation for the payment duration.
- Another example is making a smaller downpayment of around 10% and a shorter loan term of 24 months, then you will have reduced the gap to 0% within a year.
When looking into gap insurance it’s important to learn whether your existing insurance plan might already have a gap clause to protect you. This will save you the extra cost of gap protection.