1. 75 POINTS
    Charles Newsome
    “Gap insurance” is a coverage that is offered either on your auto policy or through the auto finance company as an option (or requirement) on your loan. Basically, what it does is provide you a clean slate if you total a car with a loan on it. Let’s look at an example:

    Erica buys a 2009 Volkswagon Jetta from a used car shop for $14,000. The used car value could be 12,500 depending on what form you use (blackbook value, NADA, Kelly Bluebook value, etc.) The form doesn’t matter here other than answering the question of “is this car worth less than the loan I have on it?”

    Erica is required to have other-than-collision coverage (often called “comprehensive coverage, which is a misnomer) and collision coverage as a stipulation for the loan she is getting with the bank or finance company. That coverage states that it will repair her car for specific reasons in the policy OR pay her the actual cash value of the car if it costs less than the repairs it would take to make the car drivable. Often a state variation will come here saying a car cannot be repaired if the expenses are 70% or more of the value of the car- the insurance company needs to pay the policyholder the actual cash value of the car instead.

    If you look closely at your auto policy, you also have a coverage to protect yourself from liability caused by you damaging the property of others. This is often referred to as “property damage liability” or the third number in your limits (such as 100/300/100 limits). It states that it will repair the damage caused by your actions that you are held responsible for OR pay the actual cash value of that item if less than the cost of repairs. This is important, so remember it.

    So what does this mean for Erica, knowing this information?

    Let’s say Erica has had her Volkswagon Jetta for 3 years and diligently made payments on her car without missing a payment date. The loan is now $9,000 after interest. The value of the car has depreciated down to $7600 because of the age, mileage, and usage of the car. Technically, Erica is paying $1400 more on the car than what it is worth (taking interest out of the equation to make it easier.)

    Let’s say at this 3 year mark, Erica gets into an accident and the car is beyond repair. It doesn’t matter if she causes the accident or if someone else was at fault, because both property damage (what the other party uses to fix Erica’s car if they caused the accident) and collision coverage (the coverage used to fix Erica’s car if she caused the accident) use actual cash value to determine how much repairs will be made and how much money they will pay Erica. Both coverages will give Erica $7600 for her car.

    However, since Erica has a lien on the car because she is financing it, that money actually goes to the FINANCE COMPANY and Erica won’t see a penny of it. The finance company will apply that $7600 to her loan, meaning there is a $1400 balance left she is responsible for. The bank isn’t a charity so they will still tell Erica she has to pay it because it is still in her contract and the bank lost $1400 on a car that no longer exists. Erica still has to pay $1400 on a car she doesn’t even have, and still has to buy a new car. That’s a bad place to be in life, wouldn’t you say? Even worse, Erica might still have to make payments even if the accident wasn’t her fault! She gets all of the blame of the finance company but caused none of the problems!

    If Erica had gap insurance, it would kick in at this point and relive Erica of the extra $1400 she would be responsible for. If Erica was ahead of her loan and the cash value of the car was more than the loan, she would get any money paid above the loan amount (thus satisfying her finance company as well) and the gap insurance would not take effect. Either way, Erica isn’t paying money any more on her car that is non-functional.

    Here are some common stipulations found in gap insurance- check with your loan company to see if they apply to you:

    Gap insurance is there to pay for the loan on the car and THAT’S IT! If you increase the loan to pay for any extras you are typically not going to get that part of the loan covered and will still have to pay. This includes things like the extended warranty, credit life insurance in case you die before the loan is paid off, and things like that. It might even say the gap insurance isn’t paid for either and you will have to pay for that. It’s definitely worth looking into. Gap insurance also says that it won’t take effect if you are behind on your payments on a certain amount, pay more because the car is worth less from overuse or modifications, and won’t cover intentional damage to the car. Basically, it’s not there to handle your loan if you are financially strapped and cannot handle the payments anymore and want to get rid of the car.

    Another option in place of gap insurance is to get the “repair/replacement” coverage for your auto policy. This says that instead of getting the cash value of a car beyond repair, you get a replacement car instead (even if it costs more than the value of the car.) You would still have the loan but you’d have a car as well. This coverage might not be available and it often is only available for cars less than 1-5 years old and only if you are the original owner. Talk to your agent to see if you qualify.

    Gap coverage is an excellent coverage to get, and is worth the investment. Used cars typically drop in value faster than the loan does from payments, and you don’t want to be stuck paying on a car you don’t even have anymore.
    Answered on February 20, 2013
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