When you get a new (or new-to-you) car, the salesperson and finance manager will attempt to add in all sorts of additional extras to the auto loan. While some of these are tangible, such as a nicer stereo system or a moon roof, others fall into the service category. Gap insurance is an example of the latter. Depending on your situation, it may make sense to add the cost of gap insurance into your car loan. To help you decide whether its right for you, consider the following.
What is gap insurance?
In order to determine whether gap insurance is right for you, it's helpful to first know what gap insurance is. Gap insurance will cover the difference between the balance on the loan and the value of the car. In other words, it will cover you in the event that you find yourself underwater on the loan. Gap insurance is often recommended, but it is not required.
When is gap insurance helpful?
If you are purchasing a new car and not making a very big down payment, gap insurance is almost a must. During the first three years a new car depreciates rapidly, almost always faster than the rate of payment on the loan. Its a certainty that you will have a period during the beginning of the loan where you owe more than the value of the car. If you were to total the car, the insurance would only pay the fair market value, which could be less than the value of the loan. You would be responsible for the balance...unless you had gap insurance.
Can I get around needing gap insurance?
The easiest way to get around purchasing gap insurance is to buy a used rather than new car. Ideally, you should shoot for a car with low mileage that is between 3 and 5 years old. This is old enough that the car has already taken its largest depreciation hit, yet not so old that it has a high likelihood of having major problems. If you absolutely must purchase a newer vehicle, make at least a 20% down payment. This will cover the depreciation within the first year and give you a better chance of outpacing depreciation for the balance of the car loan term.
Gap insurance is not a scam; it's definitely something that makes prefect sense for certain buyers. If you would like to find out more about the cost, ask your lender about gap insurance and whether it would make sense for the car you have in mind.