Do I Need Gap Insurance on a Used Car?
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UPDATED: Jul 14, 2021
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- Dealers and lenders usually require you to have gap coverage for new or leased vehicles as an automatic condition of purchase
- In over four to five years, you car’s value will have a depreciation rate of 40% to 60%
- Full coverage policies combine different types of car insurance policies and may include gap protection
So you’ve researched the benefits of buying a used car and learned how to negotiate used car price. Now, it’s time to find the insurance coverage you might want to have. Depending on the value of your used car and how you financed it, you may want to consider purchasing gap insurance.
Adding car gap insurance to your coverage makes the most sense for used car owners who put down lower initial payments, or have loans with longer terms on a vehicle built in recent years.
You may be wondering, “do I need gap insurance on a used car?”
The answer is no, in that it’s not a legal necessity to drive on public roads—unlike meeting your state’s minimum liability requirements.
However, the low annual cost for gap coverage typically makes it a wise addition to your policy if you have an auto loan. Some drivers only pay around $20 per year.
What is Gap Insurance?
Purchasing a car is a commitment. The financial weight of your investment may seem overwhelming and, for many people, owning a functional vehicle is a necessity for daily activities. What happens when an accident wrecks your car and prevents it from matching the commitment you made during your purchase?
If you financed your ride with a loan, you might find yourself still committed to paying it off even after a tow to the great junkyard in the sky. Lenders do not forgive auto loans if your car experiences an untimely demise. Gap insurance coverage protects the commitment and investment you’ve made, covering the debt still owed on an auto loan if it exceeds the totaled vehicle’s value.
Financed cars commonly depreciate in value below their loan’s outstanding balance. That’s the “gap.” Sometimes, “gap” refers to the literal difference between your loan’s remaining balance owed and your car’s market value, while others it’s considered an acronym for “Guaranteed Asset Protection.”
Regardless of how you or your auto insurer interprets its name, gap coverage applies the same.
Purchasing an asset with loan financing carries some inherent risk. Signing the loan agreement commits you to pay off the loan’s balance over a certain period with a set payment schedule. However, your asset’s value “depreciates” (i.e., diminishes over time) independently from your loan’s current balance.
Regardless of the purchased asset’s value at any given point over the loan’s duration, the total balance owed remains the same; continued or increased payments offer the only method for reducing the remaining debt. When its value has depreciated to a point lower than the remaining amount owed towards the loan used for the purchase, an asset is considered “underwater” or “upside-down.”1
As cars depreciate quickly, owners commonly find themselves underwater during their initial period of ownership. While many drivers never have an issue with the difference between their remaining loan balance and depreciation, any incident where your insurance provider declares your vehicle as totaled may place you in a difficult financial position.
Gap insurance acts as a scuba tank, helping you breathe easily should an accident occur while underwater.
Depreciation By the Numbers
Depreciation is easiest to demonstrate with new cars and round numbers. However, nearly all vehicles will lose significant value over time regardless of whether they are brand new or have had multiple owners. The difficulty in tracking the expected depreciation of a used car comes from determining how much value the car has already lost and its final worth at your ownership’s expected conclusion. Different vehicles depreciate at different rates.
Estimates place a vehicle’s depreciation over five years between 40% and 60% of its value. This average means that if a car costs purchasers $40,000 when brand new, it will depreciate to $24,000-$16,000 over that period.2 Depreciation rates typically fall after the first year, but a new vehicle loses an expected 10% of its value as soon as it leaves the car dealership’s lot.3
A depreciation timeline for your vehicle’s value will likely resemble the following:3
- $40,000 at purchase
- $36,000 by the time you drive home for the first time
- $32,000 at the end of the first year (20% annual depreciation)
- $27,200 at the end of the second year (15% depreciation)
- $23,120 at the end of the third year (15% depreciation)
- $19,634 at the end of the fourth year (15% depreciation)
- $16,689 at the end of the fifth year (15% depreciation)
Remaining Loan Balance
Despite the steady drop in your vehicle’s value, your auto loan balance will only diminish according to your payments. Say your hypothetical car has been declared a total loss after five years despite an $18,000 balance remaining on your auto loan. The insurance payment will only cover $16,689, according to the timeline above. The remaining $1,311 will come from your pocket unless you have gap insurance coverage.
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When Gap Insurance Makes the Most Sense for Used Cars
Deciding whether or not to add gap coverage to your insurance policy when purchasing a used car can be tricky since the vehicle has already experienced the worst of its expected depreciation. A general guideline to follow when considering car gap insurance policy argues the coverage is worth purchasing if:
- Your down payment is less than 20% of the car’s value at the time of purchase
- The duration of your auto loan will exceed 60 months (i.e., five years)
- Your vehicle depreciates faster than average
- You still carry a loan balance from your previous vehicle
Checking Value Before Buying a Used Car
Knowing what to check when buying a used car will help you determine its value. Using a site such as Kelly Blue Book makes comparing the market value of a used car easy and should be considered one of the first items to cross off your list of things to check before buying a used car. If you know the year, make, model, color, and trim level details, you can quickly determine an average value range for similar vehicles in your area.
Determining the expected value of a used car is critical to estimating your depreciation rates and preparing to negotiate for a fair price.
The Cost of Gap Insurance may Surprise You
While the value of some used models may have depreciated heavily by the time you’re considering purchasing one, the gap insurance’s affordability likely makes it a worthwhile investment. When added to collision and comprehensive coverage, gap insurance may only add $20 per year to your policy.sup>4
Gap Coverage for New Cars
Gap coverage is always a worthwhile investment on a new vehicle, although you may not have a choice of whether to add it to your policy. Dealers and lenders typically require gap coverage for new or leased vehicles as an automatic condition of purchase to protect their investment until repayment is complete.
Many dealers offer their own gap protection to purchasers for new and used cars, although better alternatives likely exist through any auto insurance company. Dealers may charge as much as 200-400% more than policy providers.4 Sometimes a dealer’s gap coverage may be a flat fee included within your purchase agreement or automatically added to your monthly payment.
If your dealer or lender requires gap insurance as part of the purchase, contact your insurance provider to ask if they offer coverage options for you to add to your existing policy.
Other Types of Optional Insurance Coverage
Not every driver takes the time to understand the different types of auto insurance policy they may be legally required to carry or that might be available. For starters, you and your vehicle are not protected following an at-fault incident (i.e., an accident you caused) if your protection only meets state minimum amounts for liability coverage. Liability insurance only covers the medical, property, and repair or new car replacement costs for victims.5
Collision and Comprehensive Coverage
Because of the lack of personal protection, many drivers add collision and comprehensive coverage to their policies. Collision coverage ensures your vehicle’s value regardless of who caused an accident. Comprehensive coverage protects your vehicle following non-collision damage (e.g., theft, vandalism, fire).
Although not a legal necessity, a car dealer, leasing agent, and insurance agent or lender usually require both types of insurance to protect their investment if you’ve secured additional auto financing for your vehicle purchase.5
Drivers who already carry collision and comprehensive coverage may question the importance of gap insurance. However, both types of insurance only cover the full market value of a totaled car, leaving you to pay for the remaining gap.
Personal Injury Protection (PIP)
Personal Injury Protection (PIP), sometimes referred to as “no fault insurance,” covers medical bills and other related expenses following an accident. PIP covers the policyholder regardless of who holds responsibility for an accident.
Some providers offer “full coverage” policies combining different types of auto insurance and may include gap protection. If you don’t know what types of coverage you currently have, contact your provider to ask.
Choose 4AutoInsuranceQuote to Find the Best Coverage
You might be asking “what other insurance policies do I need,” or “should I buy an extended warranty on a used car?” If you’re considering purchasing a used car and would like to see if you can save on your car loan as well, we’re here to help. All you need to enter is your Zip Code and some basic information about your vehicle and driving history to comparison-shop policy quotes from numerous providers. For just a few minutes of your time, you can browse full coverage options, including gap insurance.
Choose 4AutoInsuranceQuote for your insurance comparison needs.