How Gap Insurance Could Save Your Finances

Don't end up getting stuck with car payments for a vehicle you no longer have.

Car payments can be expensive and can be one of the biggest items in most people's monthly budgets. While this may be worth it for a vehicle that's needed to fulfill work or family obligations, imagine having car payments for a vehicle that has been destroyed or damaged.

Without gap insurance, that's a very real possibility.

That's why it is so important for drivers with leased cars or who have auto loans to understand how gap insurance works and why it's one of the most essential types of auto insurance coverage to buy. Here's what motorists need to know.

Why gap insurance can be a crucial form of insurance protection

Gap insurance provides coverage in situations where a vehicle is stolen and is not recovered or is totaled. It provides this coverage if the value of the vehicle is worth less than what the owner currently owes on an auto loan or would owe to buy out the lease.

See, auto insurance pays out compensation when a car is declared a total loss or if thieves take the vehicle. But insurance only pays out the amount that the vehicle is worth at the time of the collision or theft. And, in many cases, this is less than the vehicle's owner owes.

If the driver is underwater on the loan -- another name for owing more than the vehicle's current market value -- the driver would be responsible for coming up with the difference. If the car was worth $10,000 and the owner owed $15,000, for example, the owner would have to pay that extra $5,000 back.

Unfortunately, a huge number of people with financed or leased vehicles are underwater and could find themselves in exactly this situation. There are a few reasons for this.

First and foremost, cars depreciate quickly. Anyone who has purchased a new car will likely see it lose around 20% of its value after driving it off the dealer's lot. This could lead almost immediately to being underwater.

Many people also make low down payments when buying cars and/or take out loans with long repayment timelines. This means they don't pay down their balance very quickly even as the car rapidly loses value.

For many people, coming up with thousands of dollars to pay for a vehicle that has been stolen or destroyed is difficult and could create huge financial strain. Gap insurance ensures that doesn't happen. A gap insurance policy covers the remaining balance due on the loan or lease above and beyond what the insurer pays so the driver ends up being able to walk away from the crash without owing any further money to the lender.

In most cases, lenders and leasing companies require the purchase of gap insurance to make certain they actually get paid after a car is stolen or totaled. But even when this isn't the case, drivers who don't want to face serious financial loss by making payments on a car they no longer own should make sure they buy this coverage when getting their auto insurance policies.