Auto Gap Insurance: Do You Need It?

Most of you probably haven’t even heard of a thing called auto gap insurance, and that’s probably a good thing.  In general, there are very few situations where you would find yourself in need of auto gap insurance at all if you’ve been following sound personal finance principles (minimize debt, pay cash, don’t borrow to buy a depreciating asset, etc).

What is Auto Gap Insurance?

Gap insurance is beneficial when you are upside down on a car loan.  Say you own a vehicle worth $5,000 but still owe $7,500 to your lender (not an uncommon scenario if you made a relatively small down payment).  Were you to get into an accident and your car totaled, the insurance company of the at-fault driver would pay you $5,000 – exactly what your car is worth:  no more, no less.  Unfortunately, you would still owe an additional $2,500 on your auto loan you’d have to pay off, and no car to show for it.  This is where gap insurance comes in:  your insurer would step forward and pay off the remaining $2,500 loan balance, leaving you debt-free.

Most gap policies also cover things like theft and other disasters, but there are almost always strings attached. If you aren’t compliant with the terms of your insurance contract at all times, your insurer may be able to legally refuse to pay your claim at the last minute.

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Do You Need It?

My first instinct is to say no, you absolutely do not need auto gap insurance?  Why?  Because it’s simply not a good idea to finance an expensive new car with very little down in most cases.  If you can afford to put at least 20% down on your vehicle (or better yet, pay cash) there is absolutely no need for you to go to the additional expense of purchasing gap insurance.  That said, I know the real world doesn’t work that way.  Here are the only two scenarios I can think of where gap insurance makes financial sense.

1. You purchased a new car with little or no down payment – Yes, this is a bad idea.  No, I don’t recommend it.  But it happens so often that I can’t simply leave it at that.  Since new vehicles often lose as much as 20% of their value just a few months off the lot, it makes sense to purchase a gap insurance policy if you put down less than 20% on a new vehicle, just in case.  If you go the used car route (recommended), this number is likely to be significantly less since used vehicles usually don’t depreciate nearly as quickly as new cars do.  Still, if you put nothing down on a used car it might be worth looking into:  it’s a borderline case.
2. You lease a new vehicle – The only other time gap insurance makes sense is when leasing a new vehicle.  In fact, many lease agreements outright require it.

Check Your Existing Coverage First

Last but not least, many comprehensive and collision auto insurance packages already include a provision to pay off the full amount of your loan in the event of a covered accident, even if you owe more than your car is worth.  Needless to say, it doesn’t make sense to purchase gap insurance if you’re already covered.