If you’ve ever bought a new car, you know the car’s value drops as soon as you leave the dealership.
That’s especially true if you’re in an accident. The value the insurance company gives your totaled car may be less than the cost to buy the same make and model again — even if your car was only a few weeks old.
That leaves you to cover the difference, unless you’ve invested in gap coverage. Here’s how gap insurance works, and how it could save you thousands.
My new car nightmare
In 2012, I bought my first-ever new car in cash. It was a basic, entry-level sedan, but to me it was better than an Aston Martin.
But just three weeks after I bought it — with only 600 miles on the odometer — a driver ran a red light, plowed into my little car, and totaled it. I, mercifully, walked away unscathed; the new sedan did its job and protected me.
The driver admitted his fault and had good insurance, so I thought everything would be covered and I would get a new, similar car.
However, I soon found out that my car depreciated a great deal during those three weeks, and the insurance payout was $2,000 less than my car cost. Without gap car insurance, I was out of luck.
I had to pay out of my own pocket to replace my vehicle, even though the driver was completely at fault. It was a tough lesson to learn.
Car values depreciate fast
According to Edmunds, your car drops in value by nearly 10 percent the minute you leave the lot. After just one year, your car’s value can decrease by $5,000 or more.
While depreciation can be a big problem if you bought the car outright like I did, it can be even more complicated if you financed your purchase. According to Jared Staver, a car accident lawyer, lots of people are driving cars that are worth less than they cost to replace.
“Many people are driving vehicles that are worth less than what they owe. The value of a car can depreciate quickly. Additionally, it can take a significant amount of time before you pay enough on a car loan to have equity in your vehicle,” says Staver.
What you owe on your car versus what it’s actually worth can become a major issue if you’re in an accident and the insurance company declares your car a total loss.
For example, let’s say you financed your new car with no money down, and it cost $30,000. A month after you bought it, you’re in an accident and it’s a total loss. You still owe over $29,000 for the car, but thanks to a depreciation rate of 10 percent, it’s only worth $27,000.
Even if you have a comprehensive collision policy, you’re responsible for that $2,000 difference and the cost of your deductible. That means you can end up paying thousands out of pocket.
“Traditional collision insurance will only pay the market value for your totaled car — even if you’re not at fault and someone else’s insurance policy is paying for your totaled vehicle,” says Staver.
What is gap coverage?
“Without gap insurance, you may end up still on the hook for any loan balance beyond the market value of your car, which can put you in a difficult position when you need to replace your car after the accident,” says Staver.
When you rely on your car for transportation to work, you may have to come up with thousands of dollars on short notice to get a new car.
“You may find that you still owe thousands of dollars on your totaled vehicle and don’t have cash leftover from the insurance payout to put toward a new vehicle,” says Staver.
Gap coverage is protection you can add to your car insurance policy when you buy a car. With gap insurance, the insurance company covers the price difference instead of you.
In most cases, you won’t need gap insurance if pay for your car outright; my situation was an extreme example. Gap coverage is most useful for people who finance their cars, since you may owe far more than the car is worth. That way, if your car is in an accident, you won’t be on the hook.
How much does gap insurance cost?
Many dealerships offer gap coverage policies, but they can be more expensive than coverage purchased through your own auto insurer. While dealerships may charge $500 to $1,000, you can likely get gap insurance from your car insurer for a few extra dollars a month.
Keep an eye on your vehicle’s value. Once the amount you owe on your car loan is less than your car’s value, you can safely cancel your gap coverage.
Is gap insurance worth it?
While gap coverage is not necessary for everyone, consider adding a gap insurance cost to your policy if you’re buying or leasing a new car. Doing so can help save you thousands in case of theft or an accident.
For more information on auto insurance, see how a good credit score can help you save money on a new car insurance policy.
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1 Important Disclosures for Earnest.
To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants will qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest fixed rate loan rates range from 3.89% APR (with Auto Pay) to 5.87% APR (with Auto Pay). Variable rate loan rates range from 2.47% APR (with Auto Pay) to 5.87% APR (with Auto Pay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms 10 years or less. For loan terms of 10 years to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 1.82% and 5.50% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of Month/Day/Year, and are subject to change based on market conditions and borrower eligibility.
Auto Pay discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
The information provided on this page is updated as of 08/21/18. Earnest reserves the right to change, pause, or terminate product offerings at any time without notice. Earnest loans are originated by Earnest Operations LLC. California Finance Lender License 6054788. NMLS # 1204917. Earnest Operations LLC is located at 302 2nd Street, Suite 401N, San Francisco, CA 94107. Terms and Conditions apply. Visit https://www.earnest.com/terms-of-service, email us at firstname.lastname@example.org, or call 888-601-2801 for more information on ourstudent loan refinance product.
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2 Important Disclosures for Laurel Road.
Laurel Road Disclosures
3 Important Disclosures for SoFi.
4 Important Disclosures for LendKey.
Refinancing via LendKey.com is only available for applicants with qualified private education loans from an eligible institution. Loans that were used for exam preparation classes, including, but not limited to, loans for LSAT, MCAT, GMAT, and GRE preparation, are not eligible for refinancing with a lender via LendKey.com. If you currently have any of these exam preparation loans, you should not include them in an application to refinance your student loans on this website. Applicants must be either U.S. citizens or Permanent Residents in an eligible state to qualify for a loan. Certain membership requirements (including the opening of a share account and any applicable association fees in connection with membership) may apply in the event that an applicant wishes to accept a loan offer from a credit union lender. Lenders participating on LendKey.com reserve the right to modify or discontinue the products, terms, and benefits offered on this website at any time without notice. LendKey Technologies, Inc. is not affiliated with, nor does it endorse, any educational institution.
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6 Important Disclosures for Citizens Bank.
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