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If you own a house, a car, a musical instrument, or anything else of significant value, chances are you've heard the word depreciation. It refers to the gradual reduction in value of items, once they've been used. Houses depreciate slowly. Well-made musical instruments actually appreciate in value (that is, their value increases), and as we all know, a car's value depreciates the second you drive it off the lot. Most of the time, this is a non issue, but if your car is financed or leased, and something dire happens to it early in your term, or in the first two years of ownership, this depreciation can cause issues with your insurance.

Let me illustrate: You leased a car three months ago, based on a value of $27,250. You begin making payments at about $500 a month, but then one night there's a huge storm, and a light pole is ripped from the ground and lands on your car, destroying it beyond reasonable repair. As soon as the power comes back on, you phone your insurance company, and they begin the numbers dance, finally determining that your barely-used three-month-old car has already lost twenty percent of its value, and they'll give you $21,800 for it. That's great, except that your finance company says, "Wait a minute. You still owe a balance on your lease, and, in fact, with taxes and fees and whatnot, you owe $29,500." That's a difference of $7,700, and it is precisely why you need gap insurance.

What is Gap Insurance?

What is gap insurance? Put simply, it is extra insurance that fills the gap between what your insurance company will pay if your car is stolen or totaled, and the balance of your loan or lease. In the above scenario, it would have covered that $7,700.

When you lease a car, gap insurance is often included in the terms of the lease, or at least required by it. If you buy a car, but finance the purchase with a loan, gap insurance can still benefit you, because unless your down payment was significant, there is a strong likelihood that your loan is bigger than the insured value of your car, even after just a few months.

As with regular auto insurance, gap insurance comes in many different amounts of coverage and associated premiums, and can often be purchased from your regular insurance company. If gap insurance is a requirement of your lease contract, but not included, check with your existing company first, then go looking farther afield. As well, check to see if your contract includes a gap waiver instead. A gap waiver is a contract clause which declares that you are not responsible for gap charges, thus eliminating your need for gap coverage.

Loan contracts, unlike leases, never include gap insurance, and never include gap waivers, though your insurance policy may make such overage unnecessary. Before purchasing gap insurance, therefore, read through your policy, or call your insurance company and ask.

A few points you should remember whether your vehicle is leased or financed are:

  1. If you have a loan, not a lease, your existing insurance policy may be written to pay off the fully financed amount, in which case you do not need gap coverage.
  2. Most gap insurance is purchased at the time a lease is initiated, but there are some companies who will sell it after the fact.
  3. If you do not maintain collision and comprehensive automobile insurance coverage, your gap coverage may not be honored. (Regular coverage is usually also a requirement of your contract or loan, in any case.)
  4. If you break the terms of your loan or lease, your gap insurance my not cover you.

Gap insurance can save your financial life in the event your car is stolen or totaled. Plan ahead, and ask your insurance agent about gap insurance along with regular coverage, even before you set foot on a car lot.

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