How does GAP insurance work when a car is totaled?

If you total a brand new car, you could end up making payments to the bank even if have insurance. That's where GAP coverage comes into play. See more car safety pictures.
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Let's play a game of "what if." Say you buy a brand-new car, and one week after buying it -- with that unmistakable new car smell still filling your nostrils -- you get in a nasty accident and total the car. (We know, we know: You're an impeccable driver, and that sort of thing would never happen to you, but just play along.) As everyone knows, a new car loses value the minute it leaves the lot; according to some estimates, a new car depreciates by 9 to 11 percent in the first day. So, if you took out a loan to buy your now-totaled car, chances are you owe more than the car is actually worth [source: Edmunds.com].

If the car owner in this scenario didn't have GAP insurance, they'd have to continue making payments on a totaled car in order to pay off the outstanding debt. How absurd! That's where GAP insurance comes into play. GAP insurance covers the difference between what a car owner owes and what his or her car is actually worth, and in some cases, it covers regular auto insurance deductibles, as well. So, instead of continuing to make payments on a car that's in the junkyard, GAP insurance swoops in and wipes the slate clean.

Why are we capitalizing GAP? It's actually an acronym that stands for "Guaranteed Auto Protection." The guarantee is that in the event of a total loss, GAP insurance will cover your financial obligations, and leave you free to start hunting for a new car, bike, scooter or whatever you choose as your replacement vehicle.

GAP insurance isn't for everyone, though. In fact, there are only a few circumstances (like the one outlined above) in which it would make sense to have GAP insurance. For a more detailed look at who does and doesn't need GAP insurance, and how much it can end up costing you, keep reading.

When do you need GAP insurance?

There are several situations where it makes good sense to cover your car with GAP insurance, but there are far more scenarios where GAP insurance makes no sense at all. So before running out and adding it to your existing auto insurance policy, you should carefully consider whether your car needs to be covered.

The most straightforward example of when you should obtain GAP insurance is if you're upside down, or have negative equity, on your car. What does that mean? When we use "upside down" in this context we don't mean that you've rolled the car over and are waiting for emergency services to come right the ship; it simply means that you owe more on the car than it's actually worth. Unless you paid cash for the car, you might be upside down on it for the first few months, or longer if you miss one or more payments [source: Reed].

If you're leasing a car, chances are good that the dealership will require you to get GAP insurance. Why? Because like an owner-driven car, in most cases, the lease insurance will only cover the cash value of the car. And if you're leasing a new car (as most leaseholders are), the cash value of the car is probably lower than what is still owed on the car. In the event that you total a leased car, you'll still be responsible for the difference between the car's actual market value and the remaining balance to pay off the lease -- unless you have GAP insurance. Just like with a non-leased car, having GAP insurance will save you the trouble of continuing to make payments on a car that's been reduced to scrap metal [source: Weston].

OK, so there are a couple of examples of when you do need GAP insurance -- when you're upside down on the car and when you are leasing -- but there are far more situations where it doesn't make sense to have GAP insurance. In virtually every other scenario, not only are you not required to have GAP insurance, but in many cases, it wouldn't make a shred of sense for you to have it. If you have a beat-up 1979 El Camino that you bought from your brother-in-law for $500, you, of course, don't need GAP insurance, but similarly, if you bought a new car at the dealership and put down a hefty down payment, you also don't need it.

Is GAP insurance worth the cost?

As with any type of insurance, the question of whether or not to get insurance and what type of policy you get all depends on how valuable the item you're getting insured is, but it also comes down to dollars and cents. GAP insurance is just a tiny fraction of the total cost of your auto insurance, and it can wind up saving you a bundle. Typically, GAP insurance costs about 5 or 6 percent of your annual insurance premium, so if your existing collision and comprehensive costs are, say, $400 per year, GAP insurance will add just 20 bucks to your overall insurance costs [source: Gusner].

If you decide that you want to get GAP insurance, there are a couple of different routes you can take. If you buy a new car from a dealer, you can often get GAP insurance from the dealership, or you can get it through an insurance agency. However, not all insurance companies offer GAP insurance, and many of those that do will require you to already have collision and comprehensive coverage. GAP insurance is typically cheaper if you buy it through your insurance agency instead of getting it from the dealership [source: Crowe].

There are still a few things to consider: Only get GAP insurance as long as you need it. This is a no-brainer, but once you've signed on for a recurring payment, like insurance, it's often easy to continue making payments without considering whether you still need the service. For car owners, it only makes sense to have GAP insurance while you're still paying off the loan, and even then, you should probably only have it while you're still upside down on the car. So if you end up selling the car or paying off the loan faster than you originally expected to, don't forget to cancel your GAP insurance! And if you paid your whole GAP insurance premium up-front and you sell or refinance your loan, you should be entitled to get at least a partial refund [source: Caucutt].

Author's Note

I came into this article knowing that buying a new car is one of the least-savvy investments you can make, and after spending some time thinking about GAP insurance, I now think it's even crazier. For example, if you go out and buy a new car for, say, $50,000, you know that by the time you're finished paying it off, the car will only be worth a fraction of what you originally paid. It's the nature of cars. But even with this in mind, thousands of people not only purchase new cars, but they also get GAP insurance on top of all the other expenses, just to make sure they don't reallyend up on the losing end of things. I'll take the bus, thank you.

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Sources

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