Following a car accident in which your vehicle is declared a total loss, your insurance company will indemnify your loss by giving you the current value of your vehicle, regardless of the outstanding debt balance on your vehicle.
That means that if a car identical to yours has a resale value of $9 000, that’s what you will receive from your insurance company – even if you still owe $12 000 on it.
You can avoid that shortfall by having GAP (Guaranteed Auto Protection) insurance, which will cover that difference. It’s particularly useful if you have a new car, because as soon as you drive it off the lot it becomes “used” and its value can drop by about 20% right away, before you’ve even made a car payment.
For example, if your new car cost $25 000, its value would drop to about $20 000 as soon as you buy it – but you still owe the full $25 000 on your loan. If you crash when you leave the dealership and your car is written off, GAP insurance would give you the full $25 000. Without GAP insurance you would only get the value of a comparable used car, in this case $20 000.