Does Gap Insurance Cover the Depreciation on Your New Car?

February 21, 2024

What is Gap Insurance?

Gap insurance is a type of auto insurance that helps pay the difference between what your car is worth and what you still owe on your loan or lease if your car is totaled or stolen. 

What is Gap Insurance?

Gap insurance is a type of auto insurance that helps pay the difference between what your car is worth and what you still owe on your loan or lease if your car is totaled or stolen. 

There are three main types of gap insurance:

New car gap insurance – Covers the depreciation gap between the original purchase price of a new car and its actual cash value if it’s totaled early in the loan or lease.

Used car gap insurance – Covers the difference between the value of a used car and the remaining loan balance if it’s totaled. 

Lease gap insurance – Covers the gap between the remaining lease payments and the car’s actual cash value if it’s totaled during the lease.

Gap insurance helps pay off your remaining loan balance so you don’t end up owing more than your car is worth after an accident or theft. It covers the depreciation gap that occurs in the early years of ownership as a new car loses value rapidly. 

Gap insurance is not the same as standard auto insurance. It only covers the difference between the car’s value and loan balance, not repairs or medical bills. It protects you financially if the car is determined to be a total loss.

Depreciation Explained

Depreciation refers to the loss of an asset’s value over time. There are two main types of depreciation:

Normal Depreciation

Normal depreciation is the gradual decrease in an asset’s value over its useful life due to wear and tear, age, and obsolescence. For example, a car will slowly lose value as it accumulates mileage and ages over time.

Accelerated Depreciation

Accelerated depreciation accounts for a higher loss of asset value in the earlier years of an asset’s life. This is done to maximize tax deductions in the asset’s early years. Accelerated depreciation methods include double declining balance and sum-of-years-digits.

There are several factors that contribute to an asset’s depreciation over time:

Wear and tear – Normal use of an asset causes it to deteriorate and lose function or value. The more an asset is used, the more wear it experiences.

Age – As assets get older, they become more outdated and less valuable. Newer models or versions often make older assets worth less.

Obsolescence – When an asset becomes obsolete due to technological advances or changing consumer demand, its value decreases rapidly. For example, older electronics lose value quickly.

Damage or repairs – Major damage or excessive repairs can accelerate depreciation and lower resale value more quickly.

Mileage or usage – For vehicles and equipment, increased mileage or usage results in more wear and tear, shortening useful life.

Environment – Exposure to harsh environments or conditions can accelerate wear and tear and depreciation.

In summary, depreciation is the measurable loss of an asset’s value over time due to a variety of factors. Understanding how and why assets depreciate allows for more accurate asset valuation.

Does Gap Insurance Cover Depreciation?

Gap insurance does not directly cover the normal depreciation that occurs to a vehicle over time. Depreciation is the decrease in a vehicle’s value from the time it was purchased until the current date. All vehicles naturally depreciate as they age and accumulate miles.

Gap insurance kicks in when there is a total loss on a vehicle, such as from an accident or theft. In the event of a total loss, your insurance company will pay out the actual cash value (ACV) of your vehicle. The ACV takes depreciation into account and is usually less than the remaining loan balance you may owe on the vehicle. 

This is where gap insurance comes in. Gap insurance will cover the difference between the ACV payout from your insurance company and the remaining loan balance. While it does not cover the normal depreciation that occurred over time, gap insurance does cover the depreciation difference between the vehicle’s current value and your remaining loan amount.

So in summary, gap insurance does not directly reimburse you for normal depreciation costs. But in the event of a total loss, gap insurance will pay the depreciation difference between what your vehicle is worth and what you still owe on your loan. This protects you from being underwater on your loan and having to pay out of pocket after an accident or theft.

When Gap Insurance Applies

Gap insurance only applies in certain situations involving a total loss of the vehicle. This includes if the vehicle is stolen, damaged in an accident, or damaged beyond repair due to a natural disaster or other incident. 

The key factor is that the primary insurance carrier writes off the vehicle as a total loss. This means the insurance company determines it is not economically feasible to repair the vehicle and instead pays the insured the actual cash value or replacement value specified in the policy.

Once the primary insurance company declares the vehicle a total loss and issues payment, the difference between the payout amount and the remaining loan balance is where gap insurance comes into play. Gap insurance will pay this difference directly to the lender, up to the amount specified in the gap policy.

So in summary, gap insurance only applies when:

The vehicle suffers a total loss from theft, accident, or natural disaster.

The primary insurance carrier deems the vehicle not worth repairing.

The primary insurance pays out the actual cash value or replacement value.  

A loan balance remains after the primary insurance payout.

The key trigger points are the total loss declaration and payout by the primary auto insurance company. Without these events occurring, gap insurance will not provide any coverage or payment.

Limitations of Gap Insurance

Gap insurance has some important limitations to be aware of. Here are some of the key things gap insurance does not cover:

Extended warranties – Gap insurance only covers the difference between actual cash value and remaining loan balance. It does not apply to extended warranties or service contracts you may have purchased for the vehicle.

Insurance deductibles – If you file a claim with your standard auto insurance policy, you will still need to pay the deductible yourself. Gap insurance will not reimburse you for the deductible amount.

Late fees – Gap insurance only covers the deficiency balance, not any additional late fees or penalties you incur. Make sure to continue making timely loan payments even if your vehicle is totaled.

Coverage limits – Most gap insurance policies have set maximum coverage limits, such as $50,000. If the difference between ACV and remaining loan balance exceeds the limit, you’ll be responsible for the overage.

Exclusions – Gap insurers may exclude certain types of losses from eligibility, such as an accident caused while driving under the influence. Other exclusions can include cosmetic damage, pre-existing conditions, improper servicing, and more.

The limitations and exclusions can vary quite a bit between insurers. It’s important to read the gap insurance policy documents carefully so you fully understand what is and is not covered. Don’t assume you’ll be fully reimbursed for any deficiency balance in every scenario. Be sure to consider the coverage limitations prior to purchasing a policy.

Getting Gap Insurance

You have two main options for obtaining gap insurance coverage:

From Your Auto Dealership 

The most common way to get gap insurance is to purchase it directly from the auto dealership when you buy your new or used car. The dealer will likely offer it to you as an add-on option along with things like extended warranties. This can be a convenient way to bundle gap coverage right into your auto financing.

Dealership gap insurance is also usually less expensive than getting a standalone policy. However, you’ll need to note what insurance company is actually providing the coverage. That way you can check on policy limitations and exclusions.

As a Standalone Policy

Instead of going through the dealer, you can buy a gap insurance policy from an insurance company. This route may give you more flexibility and customization options. For example, you may be able to choose your deductible amount.

A standalone gap policy will likely be more expensive than the dealership option. So weigh the costs vs. benefits. But it does allow you to shop around for the best rate from leading insurers.

No matter where you get it, be sure to read the full policy to understand exactly what’s covered and what’s not. The Gap insurance has important limitations to be aware of.

Gap Insurance Cost

Gap insurance is an additional cost that gets added to your auto loan if you choose to purchase it. On average, gap insurance costs between $300-$400. However, the exact cost can vary depending on several factors:

Type of vehicle – Gap insurance for a new car that has high depreciation will cost more than for a used car. Luxury and specialty vehicles also tend to have higher gap insurance rates.

Loan length – Longer auto loan terms mean you’ll pay more overall for gap insurance since you pay a monthly fee. A 72 month loan will have higher gap insurance costs than a 60 month loan.

Lender – Some lenders might markup the price of gap insurance more than others. Gap insurance purchased from a car dealership is often more expensive than getting it from your auto insurance company.

Coverage amount – Getting gap insurance for 100% of the value of your loan will be more expensive than opting for cheaper plans that cover less. Most gap insurance plans cover 20-25% above the value of the car.

State – Auto insurance regulations can impact gap insurance pricing in some states. California, New York, and New Hampshire tend to have higher gap insurance costs.

The cost is usually rolled into your monthly car payment when you purchase gap coverage from the dealer or lender. Gap insurance can provide valuable protection, but it’s wise to compare quotes from different providers before purchasing.

Is Gap Insurance Worth It?

Whether or not gap insurance is worth it depends on several factors:

Pros of Getting Gap Insurance

Covers the gap between what your car insurance pays and what you still owe on your loan if your car is totaled. This prevents you from having to come up with a large sum of money to pay off your loan.

Provides peace of mind in knowing you won’t be stuck with negative equity if your car is totaled early on in your loan term.

Typically relatively inexpensive compared to the amount of protection it provides.

Cons of Getting Gap Insurance

An added monthly cost on top of your car payment and insurance premiums.

Covers a relatively rare scenario of having a total loss soon after purchase. For many, it’s an unnecessary expense.

Doesn’t cover other types of car-related losses besides total losses from collisions.

When Gap Insurance Is Most Worthwhile

Gap insurance tends to provide the most value when:

You make a smaller down payment of less than 20%. With more owed than the car is worth, gap coverage protects from negative equity.

You take out a long-term loan of 5-6 years. Depreciation early in the loan term creates a larger gap in value.

You purchase a new or lightly used luxury or SUV model. These tend to depreciate faster than other types of vehicles.

You don’t have substantial savings set aside to cover the gap amount if needed.

On cheaper, shorter-term loans for vehicles that hold value well, gap insurance is less likely to be needed. Take your specific situation into account when deciding if it’s a worthwhile expense.

Alternatives to Gap Insurance

Instead of purchasing gap insurance, some people choose to self-insure against depreciation in other ways:

Self-Insuring Savings Account

You can create your own “gap insurance” by consistently depositing money into a separate savings account. If your car is totaled, you can withdraw from this account to cover the difference between what your auto insurance pays out and what you still owe on your loan. 

The advantage of this method is that you aren’t paying gap insurance premiums. The money is yours to keep if you don’t end up needing it. The downside is that it requires discipline to consistently set aside savings, and you need to be sure you’re depositing enough to fully cover a potential gap.

Paying Off Loan Quickly 

You can minimize depreciation gap risk by structuring your auto loan so you pay it off as quickly as possible. Opt for the shortest loan term you can afford and try to pay extra principal each month. This will ensure you owe less than the car’s value over time.

The faster you pay down the loan, the smaller any depreciation gap will be if the car is totaled. Just be aware that shorter loan terms mean higher monthly payments.

Careful Driving

Driving carefully and avoiding accidents is another way to reduce the chance you’ll need gap insurance. The goal is to prevent your car from being totaled in the first place.

Defensive driving techniques like leaving plenty of following distance, signaling turns, and avoiding distractions can help keep you out of collisions. You can also install safety features like backup cameras and collision warning systems. 

While being a safe driver requires effort, it costs nothing and helps avoid the stress of an accident – not to mention potential gaps between insurance payouts and remaining loan balances.

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