When it comes to your automobile ownership, an insurance gap occurs when you have a loan on the vehicle. It is first important to note that if you have a loan the lender will require that you carry collision and comprehensive coverage on the vehicle. This is because your loan is secured by the economic value of the vehicle. It is important to that lender that the value remains as high as possible throughout the period of your loan repayment. With that being said, gap insurance is a somewhat confounding concept.
Gap insurance covers the difference between the real value of a vehicle and the loan balance on a given day. The reason that the concept of gap insurance is confounding is that lenders who often require gap insurance are basically acknowledging that they have loaned money toward a piece of property, your car, that becomes worth less through the passage of time. This drop in value usually occurs at a rate that is faster than the rate that the typical auto loan is paid off. A vehicle that depreciates below the loan balance is commonly called “upside down”
In order to determine if you need gap insurance, it is important to know what type of policy you have on your vehicle. Most auto insurance policies will pay for the replacement of a totaled vehicle on an actual cash value bases. Actual cash value means the difference replacement cost less depreciation. Depreciation on a vehicle is not typically calculated with any formulas but is rather determined by market value by comparing the selling price of other vehicles with the same make, model and year. Some policies will pay for the replacement of the vehicle on a “stated value” basis. Stated value policies are typically used for antique cars or limited edition cars that are in some way a rarity. If you have a typical automobile policy, you may need to be concerned about whether or not you should have gap insurance. If you do not have a loan, gap insurance is not necessary because it is designed to fill the “gap” between the coverage and a loan value.
Once you have determined what type of policy you have you need to look at the value of your vehicle. As indicated, this is usually done through comparable sales and not any mathematical formula. The best way to do this is to check the blue book value. There are several resources for used vehicles in South Africa to research the value of your car.
If you know the value of your vehicle, your next step is to determine the balance of your loan. A simple call to your financial institution can provide this information. If the value of your loan is much more than the value of your vehicle, gap insurance may be something you should consider.
As with all insurance, the cost vs. value analysis coupled with an adjustment for risk may reveal that gap insurance may not be necessary. The cost of the insurance as compared to the shrinking gap may obviate the need for gap insurance. Just remember that both your vehicle and your loan balance decrease over time, but they may not always change at the same rate.