Collision insurance covers damage to your vehicle, but is frequently not sufficient to pay off the total car loan. Many of my clients find this out the hard way after a serious accident.
The reason for this is that the moment you drive a new vehicle off the dealer lot, your auto insurance is probably inadequate to protect you financially in the case of a total loss.
That’s because your regular auto insurance is designed to pay the lender the vehicle’s current cash value — not the current loan balance. The difference can be thousands of dollars. And we all know once your new car — owned or leased — leaves the lot, it is considered a used car and the value of it drops significantly.
In fact, the average new vehicle loses 30 percent of its value the first year. By year three, that loss in value will be close to 50 percent.
If your vehicle cost $25,000 new, your insurer would probably pay about $18,000 for a total loss during the first year. That’s a $7,000 shortfall. Depending on the amount of your down payment (or trade-in equity), you would still be responsible to your lender for the balance of the loan.
If you have car gap insurance, your insurer pays the difference, not you.
While there is no “one size fits all” answer regarding the need for GAP insurance, you’re a likely candidate for gap insurance if you:
• Lease a vehicle.
• Finance for 60 months or more.
• Put less than 20 percent down.
• Roll negative equity from a previous vehicle loan into a new vehicle loan.
• Drive more than the average 15,000 miles annually.
• Purchase a vehicle with a history of high depreciation rates.