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What Is Gap Insurance and How Does It Work?

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April 12, 2021

You’ve probably been warned that your car will lose value as soon as you drive it off the lot. And this is true. Even if it is brand new and in perfect condition, your car instantly loses value as soon as you purchase it. This is known as depreciation.

Depreciation rates for vehicles can be as high as 20% per year. This means that the first year you own your car, it can lose up to 20% of its value. If you bought your car in cash or paid your car off completely, depreciation is nothing to worry about. However, if you total a new car within the first year of buying it and still owe money on your lease or auto loan, you are expected to pay the amount you owe, even if your car’s value has depreciated to less than that amount.

This is where gap insurance plays an important role! Gap insurance stands for guaranteed asset protection. This kind of car insurance covers the gap between what you owe on your vehicle and its depreciated value or what it’s actually worth. 

In other words, in the case of an accident or any damage to your car after your car has depreciated in value, gap insurance helps you cover the difference.

Who needs gap insurance? 

Gap insurance is not required by the state like liability insurance is. Instead, gap insurance is only required by some lenders and otherwise is completely optional for car owners. It benefits different drivers depending on a variety of factors.

Gap insurance is one of the cheapest forms of car insurance coverage. It can add as little as $20 per year to your standard car insurance coverage. So, if you have an auto loan, the investment is definitely worth the benefits.

The Insurance Information Institute’s recommendation for gap insurance includes anyone who has less than a 20% down payment on their vehicle or has taken out a loan lasting longer than 60 months.

Who doesn’t need gap insurance? 

You could consider not purchasing gap insurance if your car is completely paid off. If you paid in all cash, you wouldn’t need to worry about the depreciation of your car’s value. Gap insurance is usually unavailable for car owners who’ve paid off their vehicles. And this is okay because you won’t need it unless you have an auto loan!

What causes depreciation? 

A small amount of depreciation is understandable. One second a car is brand new, and the next second it’s considered used. But depreciation rates tend to be much higher than expected. After just five years of driving your car, it is worth approximately 40% of the original value you paid for it the day you signed your lease. What causes this severe drop in value?

1. The miles on your car 

Mileage is a huge determining factor when considering the depreciation rate of your vehicle. The more you drive it, and the more miles are on it, the more wear and tear it has received. The amount of mileage can lead to engine issues or other car problems, so the more miles you have on your car, the more its value will go down.

2. How many people have owned the car 

The number of people who have owned the car also influences the rate of depreciation. This is due to the increased risk of aesthetic damage, damage to the car itself, an increase in mileage, and an overall decrease in the car’s value.

If you are looking to buy a used car, check the V5C registration or the logbook to see how many people have owned a car before you buy it. If the car has only been owned by one or two people, its value will be much higher than if it’s been owned by five or six. 

3. How many accidents you’ve been in and how much damage there is to the car 

Internal and external damage to your car is a huge influence on its depreciation rate. If you’ve been in an accident at all since you’ve leased your car, the value has likely gone down a significant amount. This concept is pretty straightforward. If your car’s been damaged, it simply is not as good as it once was.

When buying a used car, inspect the car carefully and be sure to ask about any damages, fixed or not, that may affect the value of the vehicle.

4. Your car model 

Just like technology, cars depreciate in value when a newer, better model is available. Once your car is around two or three models old, its value is severely depreciated. You likely won’t get close to what you paid for it if you want to sell it.

5. How desirable your car is 

The desirability of your car plays an important role in how much it depreciates as well. If your car has great fuel economy, it’s likely more desirable than a car that gets fewer miles to the gallon. Reliability makes a car more desirable as well, especially for reselling to those with children, or to those who are looking for a long-lasting vehicle.

The size of your car can determine its desirability, too. Most people are not looking for a big, clunky car. Smaller cars retain their value much longer than bigger cars, so most people prefer less over more!

Model and manufacturer also play a role in how desirable your vehicle is, but this is determined by individual preferences and taste. However, choosing a reliable model and manufacturer when buying your car doesn’t hurt the value. These aspects determine how desirable a car is and thus how much value it will retain over time.

How you can avoid depreciation 

Depreciation sounds pretty unavoidable. And, to a certain extent, it is. However, there are ways to minimize the amount of depreciation and maximize your car’s value while you still own it! One way to do this is to drive less! Keep your mileage down by carpooling with friends or coworkers and splitting the gas bill. The lower your car’s mileage, the more value it will retain!

Buying a used car actually helps save you the money you would lose in depreciation. You can get a nearly new model while still saving money on your car’s value that you would lose over time anyway. Figuring out which cars depreciate more than others and being aware of the factors involved will help you decide what model is best for you.

While there are measures to minimize your car’s depreciation value, if you lease your car or have an auto loan, you will still need to invest in gap insurance.

What gap insurance doesn't cover 

Gap insurance only covers the gap between the depreciated value of your car and what you still owe on it. It is important to understand that gap insurance is not the only kind of insurance you need for your vehicle. Here are some things gap insurance does not cover:

  • It does not cover medical expenses for you or any passengers in your car.

  • It does not cover the deductible for your insurance costs.

  • It does not cover any car accidents that you are liable for. In other words, if an accident is your fault, gap insurance will most likely not apply.

  • It does not cover property damage other than the vehicle itself. So, any of your belongings in the car are not covered by gap insurance.

It is important to get coverage for the things that gap insurance doesn’t cover. Liability coverage, comprehensive coverage, and collision coverage are some of the most basic types of insurance important to protecting you and your vehicle.

Where can you get gap insurance? 

Often, your insurance agent will add gap insurance onto your coverage plan for only a few dollars extra per month. If you leased a car, your lender may also have included gap insurance in your lease payments. The dealer who sold you the car may try to sell you gap insurance as well, but most likely at a much higher rate.

The only time you may have trouble finding gap insurance for your vehicle is if you’re trying to get it after you’ve leased the car. If the car is two or three models old, its value will be severely depreciated, and you will likely not be able to find gap insurance for it. If you are not the original owner or lease-holder for the vehicle, you may also have trouble finding an insurance agent who will sell you gap insurance coverage. 

Knowing which gap insurance plan is right for you can be difficult to navigate on your own, but we are here to help!

To sum it up 

In the case of an accident or any damage to your car after your car has depreciated in value, gap insurance helps cover the difference between your car’s lowered value and what you owe on it. Gap insurance coverage is especially important for lease-holders or drivers who have auto loans on their vehicles.

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