You just purchased a new car. Congratulations! If you’re like most people, your car is more than just four wheels and an engine -- it’s your baby. Purchasing gap insurance can make sure you’re covered -- in full -- if your new car is totaled or stolen.
The Loan "Gap"
Guaranteed asset protection -- or gap insurance -- is a special type of car insurance that covers the “gap” between what you owe on a car and what the car is worth if it’s totaled or stolen. Gap insurance is typically designed for car purchases in which your down payment is less than 20 percent or the length of the term of your loan is four years or more.
When you buy a car, you pay the retail price. As soon as you leave the lot, your car is worth the wholesale price — the price the dealer would pay you to buy the car from you. The difference can be thousands of dollars. Gap insurance provides a way for the owner of a vehicle to avoid the loss represented by the difference between retail and wholesale prices in the event of total loss of the vehicle. Unlike traditional auto insurance policies, gap insurance can be purchased only during the first year you own the vehicle.
Understanding Gap Insurance
Here’s how gap insurance works: Let’s say your auto loan is for $25,000. Six months later, the car’s value has dropped to $21,000. If the car is totaled or stolen, your traditional auto insurance policy will only pay $21,000 -- leaving you scrambling for $4,000 to pay off the loan. Gap insurance protects you against this.
The Importance of Gap Insurance
Three key factors have made gap insurance a must-have for new car owners. First, loan terms are becoming longer and longer. In the 1970s, the typical auto loan averaged 24 to 36 months. As of 2012, the average loan term is 64 months, and some are 70 months long or longer. Second, rebates and dealer incentives have caused vehicles to depreciate faster than ever before. And third, the probability of a car involved in an accident being declared a total loss has grown significantly. Class action lawsuits, the high cost to replace deployed airbags, crash test ratings and expensive-to-repair high-tech features all add up to a greater chance that a crashed car will be written off as a total loss -- leaving you responsible for the loan.
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