Gap insurance covers the difference between the value of your car and what you owe on it in case the car is declared a "total loss" by your insurance company due to a wreck, it being stolen or some other catastrophe such as fire, flood or storm damage.
Most people who finance or lease a vehicle owe more on their car then the vehicle's actual book value. This is especially true if you traded a vehicle in that you still owed money on. Some people will go through this cycle several times until they owe so much on their current vehicle that their payoff is hopelessly higher than the actual value of their current vehicle. In the car business this is know as being "Upside-Down!"
A JD Power study finds 38% of trade-ins are Upside-Down. This is up from 25% in 2001. This percentage will continue to increase.
Edmonds.com reports that the amount owed on Upside-Down loans averages $3,763. That's the amount over and above the vehicle's actual value.
So, if your car is totaled from an accident, from being stolen or some other covered catastrophe your insurance company will only pay the book value to cover your claim. If you owe more money on the vehicle then they give you there's a "GAP" that you must payoff.
In other words, you may end up owing several thousand dollars or more on a vehicle that has been declared a total loss by your insurance company. Once your vehicle is declared a total loss it becomes the property of the insurance company.
Gap insurance covers this "GAP" or difference so you don't get stuck owing money on a car that you don't have anymore
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