If you purchase a new car, you will most likely buy an insurance policy to protect its value, especially if you bought the car on credit. However, although your insurance policy will provide payment if your car is damaged or destroyed, it may not pay for all of your expenses. A gap insurance policy is designed to cover the difference.
A standard auto insurance policy provides coverage only for the cash value of the vehicle listed on the policy. For example, if your car is totaled in an accident, your auto insurance policy will pay you for the current cash value of the car, minus your deductible. If your car has fallen in value since you purchased it, the amount you owe on your auto loan may be higher than the reimbursement you receive from the insurance company.
If you purchase gap insurance, it will cover the difference between the fair-market value of the covered vehicle and the amount needed to repay your loan. For example, if your car's fair-market value is $20,000 but you need $30,000 to replace it, your standard insurance policy will cover the first $20,000 minus your deductible, and your gap insurance will pay the remaining $10,000. Some gap insurance policies may even reimburse you for the deductible you pay on your standard policy.
Much like a standard insurance policy, gap insurance only applies when the vehicle is damaged or destroyed by a covered event. For example, some gap insurance policies for vehicles cover accidents but not theft or natural disasters. Others will cover theft in the event that the vehicle stolen and never recovered. Covered events on your gap insurance policy may be different from the events covered by your standard policy. To ensure that your gap insurance policy covers all of the most likely causes of damage or destruction to your vehicle, ask about exclusions before purchasing the policy.
Gap insurance is available from private insurers as well as from car dealerships. You'll want to compare rates, however, because dealership policies typically cost more than private policies. Gap insurance is necessary only if the fair-market value of your vehicle is significantly different from the amount you owe the lender. Monitor this difference regularly to determine whether you need to continue coverage. Gap insurance doesn't cover interest charged on your loan, nor does it cover late fees for missed payments.
Amanda McMullen is a freelancer who has been writing professionally since 2010. She holds a bachelor's degree in mathematics and statistics and a second bachelor's degree in integrated mathematics education.