Alternate name: Gap insurance
For instance, if you bought your car and still owe $20,000 on it, it may only have a Kelly Blue Book value of $15,000. You are “upside down” on your car loan. If you are then in an accident where your car is totaled, your insurance may only pay you for the value of the car, which is $15,000. That means you still owe $5,000 to the bank for the remaining balance on your car loan. Payoff or gap insurance could help you pay the bank some or all of that remaining balance.
How Loan/Lease Payoff Insurance Works
The term “loan/lease payoff” is often used in place of gap insurance. Both coverages work in a similar way, but there are some subtle differences between the two. Providers can assign their own sets of rules to loan/lease payoff insurance that separate one type of insurance from the other. Other providers might not distinguish between the two coverages at all. Suppose that John has purchased a new Chevy truck for $28,000. He purchased the truck with a 0% down payment and an extended six-year loan to keep his payments low. Unfortunately, the truck is stolen within a month of purchase. The insurance company determines that the ACV of John’s truck is just $21,000 due to the plunging value of these vehicles when they’re driven off the lot. That’s a difference of $7,000, compared to what John owes on the loan. Luckily, John purchased loan/lease payoff coverage through his car insurance provider. This insurance will cover 25% of his ACV. It works out like this:
25% of $21,000 is $5,250. The insurance company will therefore pay $26,150 after subtracting a $100 deductible. John is responsible for paying for the remaining $1,850 balance.
John must pay out of pocket to meet his obligation, but he’s still better off than he would have been without the loan/lease payoff coverage, even though his loan wasn’t paid off in full. This is an extreme example of depreciation and no down payment, and it’s an unlikely scenario.
Loan/Lease Insurance vs. Gap Insurance
Gap insurance tends to be a bit more generous and flexible than loan/lease payoff coverage and in some critical ways. You can often avoid out-of-pocket costs at all with gap insurance. You won’t be forced to come up with a portion of the balance in order to retire the loan against the destroyed or stolen vehicle. It can provide helpful coverage even if it doesn’t pay 100% of what you owe, and it will certainly come in handy compared to not having any access to coverage when you know you’re underwater on your car loan. However, some consumer advocates argue that the premiums for these coverages often are too high given that claim payouts are fairly infrequent.
