You just bought your new dream car, all the papers are signed, you decided on full coverage for insurance and your agent assures you it is in place, time to go.

You can't help but call your friend to tell them about your new car, so, while fishing around for your cell phone, excited about the transaction … BAM, someone just plows into the side of your car.

You look around, everyone appears ok, you check for damage, you can't believe it, the car is totaled. Oh well, as long as everyone is ok, the insurance will cover it. Wrong.

While figures vary, it is estimated your “new” car can depreciate as much as 30% once you sign the papers and drive it off the lot. With that type of immediate vehicle devaluation, if we are talking about a $30,000 vehicle, that is $9,000. What is worst, the insurance’s determination of value may not actually cover the loan balance.

The difference between the amount you owe and the actual value is your equity. If that difference is not in your favor, it is called negative equity, or, in the auto world, being “upside down”.

As auto lenders offer longer financing terms and owners’ choose to keep their vehicles longer, the potential for negative amortization continues to rise. If you have comprehensive and collision as part of your auto policy, it still may not be enough.

In the 1980’s, to resolve this problem, loan payoff insurance, otherwise known as “gap insurance”, was created. Simply put, this insurance coverage pays the difference between what you owe and what the insurance company determines the value of your vehicle is.

In most cases, gap insurance also covers the deductible. In addition, this coverage protects the car against any reason, i.e. accident, vandalism and weather to name a few. You should always read your policy or check with your agent to determine what is covered, as it differs between companies.

With the rising cost of vehicles, rather leased or purchased, the cost to add gap insurance to your coverage is minimal. There are some things to take into account with respect to gap insurance, such as exclusions and requirements. In addition, some policies already have the insurance included in your premium.

Once again, you should check with your agent to be assured if gap insurance is purchased, that it will cover your vehicle.

Some of the standard exemptions associated with the insurance are a maximum coverage amount (usually $50,000), the amount financed exceeding the value (usually 120%), penalties and late fees due the lender, the annual percentage rate (usually 12.5%) and rather the note is a balloon or not.

While trying to determine if gap insurance would be an effective tool in your financial situation, always a good rule of thumb, if there is any possibility you could owe money after a total loss, is the cost of the purchase worth the amount of the premium? Only you can decide that when purchasing an automobile insurance policy containing gap insurance.