What is Gap Insurance?
As the example shows, it's understandable that some lenders require gap insurance. If John doesn't have it, he'll only be able to repay part of the (and may default on the rest) if he totals the RV. The fact that John has an interest-only loan is not what makes the difference here; many types of vehicles depreciate so rapidly that many car buyers, particularly those who get long or little down, can find themselves needing gap insurance.
It is important to , however, that the vehicle usually has to be totaled in order for a gap insurance policy to pay out.
How Does Gap Insurance Work?
By "loan outstanding on a car or RV is higher than what the vehicle is worth. So, for instance, let's say John Doe buys an RV for $100,000. He gets a $90,000 loan that requires him to only pay interest for the first three years. After three years, he still owes $90,000 on the RV, but now the RV is only worth $75,000.
If John totals the RV on his next road trip, he would file an insurance claim, which would pay for the "value" of the RV. At that point, he would get a check for $75,000. However, he'd still have the loan of $90,000 to think about. So, John needs gap insurance to cover the other $15,000. That way, if he totals the RV, his primary policy cut a check for $75,000 and his gap insurance give him another $15,000; he'll at least be able to pay off the loan.