Gap insurance is a type of insurance that financial institutions recommend when someone takes out a loan to purchase a vehicle without a sufficient down payment amount. This situation happens quite often since people sometimes decide to trade in their car on a new or better one while they still owe on their previous loan. There are various reasons people make this choice, but they often end up trading a vehicle that has a lower trade-in value than the amount they owe.
Automobile dealers are able to make the trade and help them get a loan for the new vehicle, but they end up in yet another “upside down” loan. If the borrower has good credit and adequate income, they are able to get a better vehicle. However, the financial institution that holds the loan feels they must protect their interests, so they recommend or even require, the addition of Gap Insurance to the contract.
Most people are aware that automobile insurance companies do not cover the full value of the vehicle in the case that it has been damaged beyond repair in an accident. The principle paid on a vehicle loan does not typically keep up with the depreciation value of the automobile, so the loan holder, even if they are on worker’s compensation insurance, will not be fully compensated in the case of a “totaled” vehicle.
When there has been an accident serious enough to damage a vehicle beyond repair, it is likely the driver has suffered serious injury as well. This may mean a temporary loss of income, so the loan holder may not be able to pay off the balance of the loan. Gap insurance takes care of this problem by paying off the balance of the loan in the case of a serious accident where the loan holder cannot do so.