* What exactly is the “gap”? and why does this gap needs to be insured?
Let us follow a hypothetical purchase of a 2007 Buick Terraza, one of the worst depreciating vehicles out there. The high depreciation of this vehicle will allow us to see the “gap” clearly. Here is how the value of this vehicle depriciates over time (data from Edmunds.com):
The values in the table above are what insurance companies are going to follow for a *regular* insurance. So, if you total the car within a few days after driving it off the dealer’s lot, you will get only about $24,190 from the insurance company. If you total it after Year 1, you will get $19,860 and so on.
Now, let us assume that you financed this vehicle with $0 down and 6% APR auto loan for 60 months. Your monthly payments (according to Bankrate.com) will be $623.54. Based, on this monthly payment, and accounting for the interest per year, here is how the amount you owe the financing company will look like:
Now, let us plot these values together to get the graph and observe how the gap looks like.
The shaded portion is the “gap” in the term “gap insurance”. This is the gap that needs to be insured. For example, if you total your Buick Terraza after the 1st year, your regular insurance will give you only $19,860, whereas, your financing company will ask you to shell out $26,551
to clear off your debt. There is a gap of $6,691 between these to figures and you need gap insurance if you don’t want to pay this gap amount.
