Gap insurance is purchased when you lease a vehicle. If your vehicle is determined a loss by your insurance company, whether by accident, damage or theft during your lease, you'd owe your bank for the vehicle's value instead of just the lease amount. Your insurance company would pay the bank for the vehicle's market value (instead of its retail value) and gap insurance would pay the remaining balance due.
Your Bank's Loss
To better understand the purpose of gap insurance, first understand the loss a leasing bank may sustain if your vehicle is declared a loss by your insurance company. When you lease a vehicle, your leasing bank pays the dealership the vehicle's entire value, whether you negotiated its price or not. If your vehicle is declared a loss, your bank loses the car's entire value, not just your lease amount. During a lease, you pay for about half of the vehicle's value. At the end of the lease, the bank resells the car to recoup the rest of its money.
Insurance Payoff
You're required to maintain full-coverage insurance during the term of your lease. This coverage protects the bank from total financial loss of the vehicle. Reasons for a vehicle loss might include an accident, theft or any instance in which damages and repairs exceed the car's value. Your insurance company will pay your leasing bank for the car's market value and nothing more. New cars are most affected by depreciation, losing thousands in value once purchased. Because lease payments are lower than financing, you pay toward equity slower. For this reason, your insurance payoff is unlikely to cover the bank's loss during your contract term.
Benefits of Gap Insurance
After your vehicle's market value is paid to your bank, it is very likely that the bank is still at loss for the vehicle's cost. As per your lease contract, you are responsible for paying the gap between your vehicle's market value and its actual cost. Gap insurance pays this balance so you don't have to. Without gap insurance, you would have to keep paying your bank until the vehicle's purchase price was satisfied. While paying toward the vehicle's value, your lease account would remain as an open account on your credit report, which can affect an approval for another loan or lease until the account is paid in full.
Gap Insurance Purchase and Cost
Prices for gap insurance differ by state and provider. Some states cap the cost of gap insurance to minimize provider profit. If you live in one of these states, expect to pay a one-time fee of about $100. A price that exceeds $100 results in provider profit and is negotiable. Some providers may charge in excess of $600 for gap insurance. Check with your insurance company, leasing bank or a dealership to shop costs. You'll only pay for gap insurance coverage at the beginning of your lease, as it is a condition of your leasing contract.
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