Gap Insurance. Know the Limits to This Insurance Type.
Everyone has heard the old mantra about cars losing a large percentage of their value as soon as they are driven off the lot. Most of us are willing to accept that fact along with five or more years of monthly payments to get the car we love. But what happens if the car we love is totaled in an accident soon after we purchase it?
Understanding the "Gap" in Gap Insurance
If your vehicle is totaled in an accident, your auto insurance policy will pay the actual cash value (ACV) of the car at the time of the loss. What's ACV, you ask? ACV is equal to the cost to replace the vehicle minus depreciation. Here's the question you're probably most concerned about: Is the ACV of the vehicle the same as what you still owe the lender?
Not necessarily. For example, consider a vehicle that has three years of payments equaling $15,000 left on the loan. Due to depreciation, at the time of an accident, the vehicle is only worth $10,000. The auto insurance policy pays the ACV at the time of the loss. As a result, a "gap" of $5,000 has been created and the value of gap insurance is clear.
Cars May Die, but Payments Live On
In the example above, a gap of $5,000 was created due to the total loss of the vehicle. Unfortunately, the loss of the vehicle does not equal the end of the loan. The lender will continue to require payments on every cent of the auto loan until it is paid in full, regardless of whether you still have the car. Unfortunately, that leaves you making payments on a car you no longer have, and adds an additional burden to you if you have to pay to get a new car.
Closing the Gap
Luckily, many lenders and auto insurance companies address this issue in the form of gap insurance. This product is designed to cover the gap between the value of the totaled vehicle and the amount left on that vehicle's loan created after a total loss.
Gap insurance coverage is extremely important; particularly for loans with a great deal of time/payments remaining. So if you purchase a car that you can't pay in full, it's definitely smart to include gap insurance in your coverage. Because if you couldn't pay for it completely today, you probably won't be able to should something happen. It's not fun paying for a car that no longer exists.
Make sure to ask your insurance provider if this is included in your plan or if they offer gap insurance. Hopefully you won't need it, but if you do, you'll be happy it's there.
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