Gap insurance: What it is and how it could save you thousands

Gap insurance, also known as “guaranteed auto protection” or “guaranteed asset protection”, is an optional form of auto insurance that you might need, even if you’ve never heard of it.

It is primarily intended for drivers who owe more in financing or on a lease than the actual value of their vehicle, what is also referred to as being “upside down” on a loan.

“I think it’s probably more appropriate with higher-end vehicles. They tend to depreciate faster in the first couple of years. Especially luxury vehicles,” Matthew DeLorenzo, managing editor of Kelley Blue Book, told FOX Business. “You want to be covered in case something happens.”

Even if you buy your luxury car, if you’re taking out a longer-term loan, there will likely be a period of exposure where gap insurance could be beneficial, he added. For people with two to three year leases, it is usually a viable option, though it is up to individual drivers to “do the math.”

Gap insurance doesn’t cover everything related to your vehicle, however, such as repairs, loan payments you are unable to make or the loss of value to your car if you are involved in an accident.

What it does cover is the difference between the “actual value” of your vehicle, as deemed by the insurance company, and what you still owe on the lease or loan in the event that your car is totaled in an accident or stolen. A car’s value begins to diminish as soon as it leaves the lot. In fact, on average a car can depreciate anywhere between 20% and 25% during the first two years, DeLorenzo said.

The insurance company will determine the actual cash value of your vehicle by subtracting mileage and other depreciation factors assessed at the time of the crash, from the amount you paid when the car was new. Essentially, the insurance company is only going to commit to covering the costs of your car based on its value when you crashed it, which can leave drivers with a substantial bill.

For example, DeLorenzo said the average transaction price for a vehicle is about $36,000, which could depreciate in value to $28,000 over the first two years if it crashes. If you put down $4,000, you owe $32,000. Since the car is only worth $28,000, you would be out $4,000. Gap insurance will help cover the difference, though not the deductible.

Drivers can buy gap insurance from insurers, car dealerships and financial institutions, where it is added to the collision insurance policy for vehicles. Some experts advocate against purchasing it at the dealership, where prices can be higher. DeLorenzo pointed out that dealers may view it as a way to make a bit more money on the purchase transaction, so it’s important to do your homework beforehand.

“If you have an insurance company now that you’re [dealing with, request a quote and] ask the dealer if they can beat that number,” he said. “It’s always important to have something in your back pocket.”

He also mentioned it’s important to continually check the resale value of your car to know whether you still require the coverage, or if you’re no longer exposed.