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What Is Gap Insurance and How Does It Work? Do you need gap insurance for your vehicle? Learn what gap insurance is, how much it costs, and whether it can benefit your situation.

By Entrepreneur Staff

entrepreneur daily

If you're like most other entrepreneurs, you're always seeking to protect your business (and your finances).

One way to do that is to purchase gap insurance, a type of coverage that helps pay the difference between what you owe on your car loan and what your car is worth if it's totaled in an accident.

Here's everything you need to know about how gap insurance works, how much it costs, and more.

Gap insurance defined

Gap insurance is a supplementary type of car insurance that covers the gap between what you owe on a financed or leased vehicle and the car's actual market value if it's totaled in an accident.

This type of coverage can be valuable if the amount left on the auto loan or lease becomes more significant than the actual cash value due to fluctuations in depreciation rates.

If your vehicle is stolen and not recovered, gap insurance can also help you compensate for the difference between what you paid and its current value at the time of theft.

Ultimately, gap insurance can be an essential tool to help you meet your financial obligations even when your regular policy doesn't apply.

Remember that gap coverage only applies when conventional car insurance coverage doesn't fully service your financial needs. Knowing how gap insurance works is key to understanding whether it makes sense for your situation.

Moreover, gap insurance is available on some health insurance plans, but it's more commonly known as "supplemental insurance" in that setting.

Related: 3 Things to Know About Buying Health Insurance

What are the benefits of gap insurance?

Gap insurance is a valuable option for many car owners needing an extra layer of financial protection. Say, for instance, that your car is totaled in an accident and is worth $3,000 less than the remaining loan balance.

Gap insurance can help make up the difference. It can also be beneficial when trading in a vehicle with negative equity, as it can help to offset some of those costs when rolling them over into another loan or finance agreement.

Sometimes, car insurance companies pay out in cases where there has been a significant depreciation due to age or mechanical issues. Many collectors purchase gap insurance because even a slight devaluation can significantly harm their investment.

Gap coverage isn't necessary for everyone, but could offer a helpful security net by giving you the peace of mind that you're covered in the event that anything should happen to your vehicle.

What are some other examples of gap insurance in action?

Gap insurance is worth considering if you finance or lease a vehicle with a high-interest loan. Say that you purchase a new car that costs $30,000 and is financed over six years at 5% interest.

This means you'd pay $34,786.65 throughout the loan, plus taxes and fees. If you totaled the vehicle shortly after purchasing it, it's likely that the value of the vehicle has already significantly dropped just from you driving it off the lot. Gap insurance could cover (or help cover) the remaining debt you still owe on the loan if the insurance payout is less than what you still owe.

In another example, let's say you're trading in a car with negative equity. The car is worth $10,000, but you owe $15,000 on the loan.

If you were to trade it in for a new car and roll that debt into a new loan or finance agreement, gap insurance could help cover the remaining $5,000 so that you don't have to pay out of pocket.

Related: Auto Insurance — Entrepreneur Small Business Encyclopedia

Gap insurance vs. comprehensive insurance

Gap insurance and comprehensive insurance are two different types of car insurance. Remember that gap insurance covers only the gap between what your car is worth and the amount you still owe on it; it won't pay out to fix damages.

On the other hand, comprehensive insurance covers damage to your car typically not related to actually driving, whether it's from a tree branch falling on it, fire, theft, or something else (depending on your policy). It won't pay out for any damage related to a collision with another vehicle.

Comprehensive insurance provides full coverage when combined with collision coverage. However, insurance providers typically won't pay out more than the car's current market value in either case.

This is where gap insurance comes in. Gap insurance takes your coverage one step further by filling in the deficiency between what your comprehensive policy covers and your remaining loan balance. This is why gap insurance is an optional coverage that you can add to a comprehensive or collision policy.

Related: How This All-Digital Provider Is Modernizing Car Insurance

How much does gap insurance cost?

The cost of gap insurance coverage depends on your unique situation. A policy typically costs between $400 and $700 when you get it from a car dealership and $20 to $40 when it's part of an existing car insurance policy.

But is gap insurance worth it for your used car or new vehicle? Several factors will dictate the specific price and whether you should purchase it.

Vehicle depreciation.

First and foremost, what's the average depreciated value of the car? Newer vehicles depreciate at a much faster rate than older ones. New cars typically experience the highest costs for gap insurance due to their rapid depreciation.

The specific policy.

Factors like coverage duration and policy type can also impact the overall cost of gap insurance. Most policies last between 12 and 72 months, but some offer up to 84 months.

Standalone policies don't benefit from some of the discounts associated with insurance packages, meaning they're usually more expensive. Gap insurance costs will also consider any specific deductibles and annual premiums related to the policy.

Related: 8 Tricks for Solopreneurs To Cut the Cost of Auto Insurance

How to get gap insurance.

Gap insurance is an essential form of financial protection for both car owners and lessees. Fortunately, obtaining it isn't difficult; you can typically go through your existing auto insurance provider or purchase a standalone policy through a third-party provider.

If you're buying a new vehicle, most car dealers offer gap insurance policies that you can customize to meet your needs. Gap insurance often provides additional benefits, such as rental car reimbursement or payment for certain charges when your vehicle is declared a total loss because of theft or accidental damage.

Be sure to ask about these features when shopping for a gap insurance policy so that you know what extras are included in your coverage.

No matter where you decide to buy your policy, having gap insurance on hand can help ensure that you have enough money available when unforeseen circumstances arise and you need it most.

Should you purchase gap insurance?

While it's not required, gap insurance can give you peace of mind in knowing that you'll be covered in the event of a total loss. Here are a few tips to help you decide if gap insurance is right for you.

Consider your car's value.

If you're driving a used vehicle that isn't worth much, gap insurance may not be necessary since the amount you owe is likely to be less than the value of your vehicle.

However, if you're financing a brand-new car, it's a good idea to consider gap insurance since new cars depreciate quickly and could be totaled before they're paid off.

Think about your deductible.

Your auto insurance policy will likely have a deductible, which you'll need to pay out-of-pocket before your coverage kicks in. Gap insurance may not help much if you have a high deductible because you would need to cover a significant portion of the loss yourself.

If your deductible is low, gap insurance could save you from paying a large sum of money to replace your totaled vehicle.

Determine if you qualify.

Only some qualify for gap insurance. Often, you must have collision insurance and comprehensive coverage on your vehicle to qualify, and your lender must require it. Check with your insurer or lender to find out if you are eligible.

Weigh the cost

Like any type of insurance, there's a cost associated with gap insurance. The price usually depends on factors like the make and model of your car and how much coverage you want.

Ultimately, the best way to determine your ideal gap insurance costs for a particular vehicle is to compare rates from various auto insurance companies. Doing so allows you to find the price point that best fits your budget and keep your car secure in case of an accident or other damage down the road.

Related: Find the Best Car Insurance Rates in Your Area with 'The Zebra'

What can gap insurance do for you?

Gap insurance can be a lifesaver when you experience an unexpected car accident. If your vehicle is totaled and the cost of repairs is more than the value of your car, gap insurance will cover the difference.

It's essential to remember that not all policies offer gap coverage, so be sure to ask your agent about your eligibility.

The average cost for gap insurance is just $20 to $40 per year when added to an auto insurance policy, making it an affordable option considering the potential payout.

You can get gap insurance from most major insurers or through organizations like AAA. If you purchase a gap insurance plan, research to find one that meets your needs.

For more information on insurance and business trends, visit Entrepreneur.

Entrepreneur Staff

Entrepreneur Staff


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