Why Gap Insurance Is the Car Dealer's Best Friend

Gap insurance is a common, but relatively unknown type of auto insurance. As the name suggests, it fills a gap in insurance coverage in the event that your regular car insurance doesn't pay for the full cost of your vehicle when it is totaled in an accident. Car dealers often include gap coverage on leases, and many also pitch it to customers buying new or used vehicles.

Gap on Leases

Gap insurance is very common on car leases, according to a November 2012 updated Edmunds.com article. Leasing companies often require that dealers include gap premiums in leasing contracts. Gap insurance basically covers the difference between what you owe on a loan or lease and the value of the car itself. I f you total a leased car and the insurance company pays less than what you owe on the vehicle, you may still have a financial obligation. Gap insurance pays the difference. On loaned vehicles, the leasing company wants to ensure it gets full replacement value in the same way mortgage companies require borrowers to have adequate coverage on home insurance.

Gap on Car Purchases

When you buy a new or used vehicle, the last step is to sit with the dealer's finance manager, who often tries to sell you additional warranties and insurance products. In a straight purchase, gap insurance is a more significant benefit to the car buyer. You're the one who takes a hit if your insurance payout doesn't cover what you still owe on a loan. Often, cars depreciate in value more quickly than you pay down your loan balance. With gap, you can ensure that you get full replacement value if you total the car.

Dealer Pricing

A primary reason gap insurance is so important to dealers is that the margins on actual car sales are often very thin. In fact, the ability of finance managers to sell additional finance and insurance products can make the difference in whether the sale is a profitable transaction. According to the Edmunds.com article, dealers typically charge around $600 for gap insurance, with some variance based on the car's value. This is a significant additional source of revenue.

Alternatives

While gap insurance is useful to car buyers, you can often save a few hundred dollars on premiums by shopping around on the open market. Recognizing this, some dealer finance managers automatically include gap coverage in your purchase agreement without even talking about it with the buyer. This practice is generally considered unethical, at a minimum. Buyers who want to get the best value should explore gap options before buying and review the itemized costs on the car purchase agreement before signing.