There are many reasons that a car is totaled. It could be because of an accident, flood, fire, tornado, or even vandalism or theft. Generally, if your car is totaled, the car insurance company will pay you the actual cash value at the time of the accident. This might be less than the actual retail value, and in the case of a new car, it will often be quite a bit less than the amount you still on the lease or the loan. The difference between what you owe the bank or leasing company and the amount the company actually pays is usually termed the “gap.”
Unfortunately, it is not uncommon for a new car to drop in value about 30% within a short time of the purchase. It will even immediately drop in value the minute you drive it off of the car lot. For example, if you bought a car for $25,000 and had an accident a week later, you could actually owe 20% to 30 % of the value of the car or from $5000 to $7500 above what your regular car insurance will pay.
Frequently, the dealership or the lender will offer GAP insurance to new car buyers or those who are leasing new cars in order to cover that difference, less the deductible. This is usually referred to as Loan/Lease Gap Insurance, which is an optional insurance when you purchase the regular physical damage coverage policy. For a person purchasing a car, you would be wise to look at this type of car insurance if you believe you will be upside down in the car. For instance, if you make a low down payment, if you have a high interest rated, if the car you bought is likely to depreciate rapidly, or if you rolled over additional money into the loan – such as under the car treatment for salt if you live in a wintry state where salt is used on the roads all winter.
For a person buying a car, it makes sense to get GAP car insurance if you are buying a new car that will depreciate as soon as you drive it off the lot. Your dealer or your financial institution will both generally offer this insurance. If you get it from the dealership, it may be included in the total loan of the car. If you get it from the bank, it may be included as an incentive for the financing or you may be able to purchase it separately. Also, your regular insurance company may offer this option when you ask about insuring a new car.
If you are leasing a car, you won’t actually own the car but you are still responsible for its value if it is damaged or stolen. Often, the lease payments are lower than if you were purchasing the car, so you will actually owe quite a bit if the car is totaled. You may find that many lease contracts will require you to carry GAP insurance coverage in order to have the lease.
Do not get this type of coverage if you are purchasing an older car where the gap is significantly smaller or you don’t expect to be upside-down on your loan for very long.