How Does Gap Insurance Work?

I'm Ramsey Personality and financial expert George Camel. In this video, you'll learn at least three things about gap insurance. What gap insurance is, what gap insurance does, and what gap insurance covers. And stick around until the end of the video to find out if gap insurance is something you need to buy or something you need to avoid. Now I'm sure you already know what insurance is, and you probably know a lot of insurance types like health insurance, life insurance, and auto insurance. But what in the world is gap insurance? Well, let me help you out. Gap stands for Guaranteed Asset Protection. And the asset that's being protected belongs to someone else, not you. At least not yet. Because gap insurance covers the difference between your vehicle's actual cash value versus what you still owe on the loan. Let me explain. Let's say that you buy a brand new car. And this is an expensive new car. It's going to cost you $65,000. And you're not following what we teach people to do at Ramsey Solutions yet. So instead of paying cash for your new car, you take advantage of the great deal offered by the slick-talking salesman of zero down at 2.9% APR on a 60-month loan. So before you know it, you have a $65,000 car with a $900 a month car payment. Yikes. So as soon as you get the keys and drive that car off the lot, your car's value immediately drops to $55,000, even though you still owe the finance company $65,000. So if you get into an accident and total that car, your comprehensive auto insurance will cover the $55,000 value of the car after your deductible. But here's the problem. You still owe $65,000, which means you're on the hook for $10,000. That's where gap insurance comes in. So how does gap insurance work? Well, the best way to explain how gap insurance works is to give you some sample situations where gap insurance might come in handy. If you lease a car, if you finance your car with less than a 20% down payment, if you finance a car that depreciates faster than the average car, or if the term of your loan is longer than 60 months. Okay, full disclosure, if you haven't figured it out by now, here at Ramsey Solutions, we're always going to tell you to buy your car with cash. We hate debt and would never recommend you get yourself into any of these scenarios. But if you were to finance a car, and heaven forbid, get into an accident and total your new $22,000 ride, but your insurance company will only pay you the Kelley Blue Book value of your car, which is $15,000, you'll still owe close to $22,000 because you made the dumb decision to finance a car. So the gap is $22,000 minus $15,000, which is $7,000. If you have gap insurance, your insurance covers the gap so you can pay off the loan. And there's a good chance that you'll also have to pay your deductible. Sometimes gap insurance reimburses you for your deductible, and sometimes it doesn't. You'll have to check the policy. Now remember, gap insurance covers the gap between what your car is worth and how much you owe on it if it gets totaled or stolen. It doesn't matter how your car gets destroyed. If your insurance company deems the car a total loss, your gap insurance will kick in after your basic collision or comprehensive insurance pays for the actual value of your car. There are two places you can buy gap insurance. From the finance company at the dealer and from your regular car insurance provider. But be warned, if you buy your gap insurance at the point of sale, either from the dealership or the bank financing your loan, it's expensive and you pay for everything up front. Usually between $500 and $700. And this cost is added to your loan amount, so you'll also be charged interest on what you pay for gap insurance. So if you need gap insurance, buy it from your regular car insurance provider. If you already have a car loan you can't get out of, check your coverage with an independent insurance agent to see whether or not gap insurance is included and if you still need it. Most car insurance policies add about $20 to your yearly premium to include gap insurance. An agent can also check the rest of your policy to make sure you've got the coverage you need at the best price. So if you need an insurance agent, click the link in this article to connect with one of our Ramsey Trusted Pros. Now if you owe more on your car than it's worth, it's probably best to keep the gap insurance until you're no longer upside down on your car. Because it means you'll be reimbursed the difference between your car's value and what you still owe if your car is totaled. Remember, debt is dumb and we don't want you drowning in car payments. It's always better to pay cash for your car and let your basic collision and comprehensive insurance protect you if you ever have to replace your car. But until then, it's better to be safe than sorry.