New car prices are increasing steadily, and you could buy a car and drive off the lot owing more money on the vehicle than what it is worth. This type of negative equity would be a problem if you had a total loss on the vehicle -- if you had an accident or if the vehicle was stolen. Gap insurance is a way to protect yourself in such a situation.
Negative equity is when you owe more on a vehicle than its book value. If you traded in a vehicle with negative equity to buy a new vehicle and didn't pay that difference in cash, the dealer rolled the negative equity into the new vehicle loan and you borrowed more money on the new vehicle than it was worth. Gap insurance covers negative equity in most cases of loss, but it may limit coverage depending on certain factors, such as the amount you put down on a new loan or the length of the loan term.
Leased vehicles are more likely to be in a negative equity situation, since many leases do not include down payments and the lease payments only cover the depreciation of the vehicle. Many car leases include gap insurance as part of the lease, and the cost of this insurance may be included in the lease payments or as a fee charged at the time of delivery. Gap insurance on a leased vehicle would allow you to walk away from the vehicle owing nothing in case of a total loss.
Check Auto Insurance Policy
Before purchasing a gap policy, check your car insurance policy to see if it includes gap coverage. Many policies include provisions for payoff of the loan balance as long as certain conditions are met. These conditions may be that a certain down payment was made on the vehicle purchase, you financed no more than the retail value of the car at purchase or the finance terms do not exceed a specified number of years.
Where to Purchase
You may be offered a gap policy by the dealership when you purchase a new car. The business manager will present different options at the time of delivery and also offer service contracts and other products. Check with your auto insurance carrier for less expensive coverage options. Gap coverage can also be purchased online.
Craig Woodman began writing professionally in 2007. Woodman's articles have been published in "Professional Distributor" magazine and in various online publications. He has written extensively on automotive issues, business, personal finance and recreational vehicles. Woodman is pursuing a Bachelor of Science in finance through online education.