Most people buying a new car don’t understand and presume Gap insurance to be a costly and complicated affair. If you spend a little time to understand how it works, it is quite simple really.
Before we plunge right into it, let’s understand what Gap insurance is. With the exception of property, most assets are prone to depreciation. The car once used, depreciates in value, by about 25% once it leaves the showroom. Insurance companies calculate the payout in the event of an accident based on this depreciated value of the car. Cars are either termed as slightly used, and used. The distressing part about this is a car that’s been driven for even five miles is considered slightly used and its value in the market depreciates.
For example, let’s say you bought a new sedan or station wagon, and just rolled it out of the showroom, on the way home your excited about your new car, and extra cautious of your surroundings, you drive in a defenseless and sedate manner. While stopped at a red light, a truck rams into your rear fender, breaking it along with both tail lights. A horrifying thing to happen to someone with a brand new car, but that’s far from the worst.
The moment your car was registered and driven out of the showroom; it depreciated by approximately 25% thus dropping the value of your car. Now the insurance company will tell you that the value of the car is no longer what you paid for it, the amount you paid for was for a brand new car, and your car is now slightly used, and hence your payout will be calculated based on the depreciated value. The irony in this situation is that you still owe the car manufacturer or a leasing agency the cost of a brand new car.
You have just suffered a major financial setback, not only is your new car damaged, it’s going to cost you a bomb to get it fixed! Your standard collision cover is pretty much useless in such a situation. This is not really a common occurrence, but one common enough for people to take note of it. The solution is Gap Insurance; gap insurance will cover you for that depreciated value. Let’s say for example your car depreciated by $10,000 when you drove out of the showroom, gap insurance will cover up for that and you will get a payout based on the value of the car without the depreciation factor.
Gap insurance essentially takes the amount you still owe to the car company, or leasing agency as the current value of your car. This you can see that gap insurance applies mainly to new vehicles which are bought on an installment basis. This might seem beneficial at that point in time; however, as months pass by, and the amount you owe the bank decreases, gap insurance becomes redundant.
The worst part is that most owners don’t know how depreciation works and that it affects them directly, oblivious of this fact they don’t go in for gap insurance. This can prove to be a major financial setback in the event of an accident.
Now coming to our original question, if you should take gap insurance or not, the bottom line is, it’s up to you, however it is very highly recommended for slightly used cars, for older cars it simply doesn’t make financial sense.