What is gap insurance and why do I need it?

Gap insurance usually costs a few hundred dollars and may cover you if you are in an accident and your car is deemed a total loss, but the total loss offer is not enough to pay for your loan.

Example: John owes $20,000.00 to his bank after taking out a new car loan to purchase a vehicle. A month later, John is involved in an accident, and the vehicle is totaled. The insurance company offers John $18,000.00 for the total loss of his vehicle. However, if John accepts this offer and uses the money to pay off the loan, he will still owe $2000.00 to the bank and will have no vehicle. If John cannot recover additional funds for the car, he will be personally liable for the difference between the total loss value and what he owes to the bank.

Bottom line: Gap insurance may pay the difference in your loan balance and what the insurance company pays out on a damaged vehicle. Vehicles depreciate the minute you drive off the lot, so frequently, owners are surprised when their vehicles are totaled and they end up owing money to the bank.