You buy a new car for $35,000. One year later, it is involved in a total loss accident. The insurance company states the value of the automobile was $25,000, while there is still $30,000 left to repay on the loan. All of a sudden, you have a $5,000 bill, and your car isn’t running anymore.
While the situation is not pleasant, it is a situation that many car buyers are not aware of: the amount of your auto insurance payout and the amount of your loan are two separate figures. This means it is possible for cars to depreciate faster than loan repayments are made, and this is notably true in the first couple of years after ownership.
This is why people wonder (what is gap insurance for cars) and if gap insurance is worth purchasing at all. GAP coverage is created to cover the difference between the amount you still owe on a financed or leased vehicle and the sum paid by your primary insurance policy provider following an eligible total loss. Whether or not you need it, however, depends largely on your loan and the amount of equity you have in the car.
How Does Gap Insurance Actually Work?
Taking the time to understand GAP is best done by using the example of two numbers moving at different rates.
The first is the worthiness of your vehicle. That value can begin to take a hit as soon as you hit the road.
The second is the amount that you owe on your loan. It also goes down, but in some cases, it may decrease a lot slower, and that relies on your down payment, rate, and length of loan.
Your loan amount is upside down, or underwater, on your car when the amount you’re paying exceeds the worth of your vehicle.
Now suppose you get in that situation because your vehicle is total loss.
The sticker price of the car you owe $28,000 for is $23,000, according to your insurance company. For example purposes, let’s say that the insurance settlement is $23,000, which leaves $5,000 to cover the loan.
The car may be gone, but that debt isn’t.
If you don’t have GAP protection, then you may be liable to pay that remaining value on your own. If a claim is eligible for a GAP contribution, it can be partially or fully made up if your claim is set up like that.
This is the true vision of GAP. This will not increase the value of your car, nor will it replace regular auto insurance carriers. It helps safeguard against a particular financial issue that can happen if a financed vehicle becomes a total loss.
This risk is especially relevant on newer cars, since the car may depreciate quickly in the initial years of time. The Insurance Information Institute says that vehicles typically retain about 80% of their value the first year.
What Does Gap Insurance Cover and What Doesn’t It Cover?
Now it’s worth reading the actual GAP agreement.
Generally, GAP coverage can go into effect if you finance or lease and your primary auto policy states that your car was a total loss as the result of an insured incident. It may be a big accident or a car that is stolen and never retrieved (depending on your coverage).
After two years of owning your SUV, you discover someone has stolen the car. There are still $31,000 owed, and the primary insurer rates it at $27,000.
It is a financial deficit like that $4,000 deficit that GAP is designed to fill.
There are other things to note, though: GAP is not a general insurance plan!
It’s usually not for repair costs, routine repairs, maintenance, medical expenses, damage to another person’s car, or a simple late payment on a loan. It also will not give you money just because your car has dropped in value.
Another thing you need to be aware of is negative equity in an older vehicle.
If you sell your old car before the balance is paid off and $4,000 is still left to pay, it’s an example of this. That $4,000 is added onto your new loan by the dealership.
From day one, you are now in debt on your new financing.
That might give GAP some relevance, but you don’t necessarily get a full dollar of old debt for free. The rolled-over negative equity, deductibles, overdue payments, finance charges, and additional fees may be treated differently in different GAP agreements.
Prior to signing, pose a single inquiry:
“What remains of my balance would not be covered if my car was totaled next month?”
The response may reveal a lot more than a sales pitch on the product.
Who Really Needs Gap Insurance?
GAP may not be right for every driver, and purchasing it just because you are offered it at the dealership also isn’t a great way to decide.
Rather, consider your financial position right now.
If there is a large gap, then GAP might be worth considering if there is a considerable amount more that is owed than what the car is worth. The bigger the gap between the two numbers, the more money that would be available for your total loss check.
You might be at greater risk if you made a small down payment, selected a loan that is five years or longer, financed a considerable amount of the vehicle’s purchase price, purchased a car whose residual value tends to drop fairly rapidly, or wrapped a negative equity balance from another vehicle into the new loan.
Leased vehicles can’t be neglected. GAP or other protection may be part of a lease agreement, or it may be a requirement. Go over your paperwork before getting into a separate cover-up.
Conversely, you have about $24,000 left in equity on a vehicle that you owe $18,000 on.
There is around $6000 in positive equity already. If the loss were considered a total loss and the insurer really priced the vehicle at approximately the same amount, there might not be any shortfall in the loan amount for GAP to cover.
Therefore, it cannot be too time-consuming to decide.
See what your lender’s current payoff is. Afterwards, consult what a reasonable estimate is of your car’s current value.
It is not necessary that the numbers are exact. You’re just seeking the answer to this question:
Am I upside down in my car?
This is where GAP really comes into play if the answer is yes and affording this discrepancy alone is challenging.
How Much Does GAP Insurance Cost?
Gap price may greatly differ from one location to another.
It is possible to get protection from your current auto insurance company, a dealership, a lender, a credit union, or another source. What’s essential is not to presume that the choice given when you’re purchasing the vehicle is your best or sole one.
This is significant because GAP sold by dealerships can be regarded with regard to as front-end goods that could be incorporated into your auto loan.
Placing it on the loan may appear like a painless operation. You may not see much of a difference in what you pay per month, and you don’t pay hundreds of dollars upfront.
There’s just one problem, however.
If the cost is financed into your loan, there may be a possibility that you also have to pay interest on the cost. This means that if a product seems cheap when it leaves the dealership, it’ll be more expensive when the loan is paid off in full.
Before you buy, GAP prices and coverages differ, and the Consumer Financial Protection Bureau suggests that you compare prices and coverages, and that financing the product will introduce a higher amount on which interest is charged.
Therefore, don’t just ask how much this will increase my monthly payment.
Inquire about what the total GAP cost is.
Then find out if there are other options available via your insurer or lender.
But cost should not be something the only thing you consider at all. Two similar products offered by GAP may have different benefit limits, deductible policies, cancellation and exception conditions.
If key loan components cannot be claimed due to the loan balance and at a slightly reduced price, it’s not much of a deal.
Is Gap Insurance Required When Financing a Car?
GAP is typically not required by law for most conventional auto loans, but a standard option.
It does not imply you won’t still find conditions where it is mandatory. For instance, leasing arrangements might have set terms, or GAP protection might already be covered in the lease.
This is relevant to the dealership.
Several decisions are already being made—price of the vehicle, financing, warranties, monthly payments, and add-ons. It’s only natural that, interspersed in the package, GAP is assumed to be a cost that must be purchased.
If told you need GAP in order to receive financing, inquire as to where is where in your contract it states this. You should also check with your lender directly for this requirement.
If a dealer or lender tells a consumer that he or she must get GAP from the lender before moving into a vehicle, the CFPB says the consumer should inquire as to where this requirement is reflected.
It can take 5 minutes to check and save yourself from optional protection added by the addition of the cost.
Don’t Forget to Cancel Gap Insurance When You No Longer Need It
However, deciding to buy GAP does not come to an end.
At some point, if you are invested in protection against gap insurance that doesn’t exist, you may end up paying for that protection.
Let’s look at the same car in a few years.
The balance of your loan is $17,000, and the car is valued at about $22,000. You have now come out of the water. Positive equity means that you have equity in your home.
It’s time to consider if GAP coverage is still necessary at this stage.
Funny thing is, if you want to pay off your loan early, refinance your loan, sell the car, send a payoff because the car is clearly worth more than the payoff amount, or trade in your car, all of this is a vital element to remember.
Another reason to review your contract: You may be able to get some of your money back.
In some cases, consumers may be able to recover the unearned portion of some prepaid GAP charges if they pay off or refinance their auto loan early, depending on the terms of the contract and the circumstances.
Don’t take a refund for granted.
Call your provider/ dealership/lender to find out if you are eligible, how the refund will be determined, and if you will need to fill out a form or other paperwork to cancel.
Don’t forget to review your loan periodically and not just the eve of your last payment either.
Compare these two numbers 1 or 2 times a year:
- The amount you currently owe on your car loan.
- The approximate current value of your vehicle
If the second number is much greater than the first, GAP might have been able to do the job it was purchased to do.
Frequently Asked Questions
Is GAP insurance worth it?
It’s something that you may want to think about if you owe a good deal more than your car and couldn’t afford to pay the difference if it was totaled. It may not be worthwhile if you already have a significant amount of positive equity.
Does gap insurance cover the entire remaining loan?
Not always. The amount that is paid will depend on coverage limits, deductibles, overdue payments, and other exclusions and carryover negative equity. Details of eligibility are defined by your particular GAP agreement.
Can you buy gap insurance after purchasing a car?
Often, yes. Certain insurers or lenders offer the addition of GAP insurance after the vehicle is bought, and the terms of eligibility and time frames can differ with the provider.
Can you get gap insurance on a used car?
Potentially. The upside is it doesn’t really matter if you are negative or not. Regardless of whether you buy a car, a seriously used car, with a minimal or even zero down payment and a lengthy financing period, or if you roll your owed loan into a new loan, you can end up owning more debt than what you are driving.
Can you cancel gap insurance?
Yes, depending on the provider and contract. However, if you’ve paid off a loan early, for example, you may also be able to get part of the unused GAP charged refunded.
Conclusion
GAP insurance alleviates one issue in particular but very costly that people may have: They are owed more money on the car than the insurance company will pay after it has been deemed a total loss in an accident. It may be wise if you have paid the lion’s share of the purchase price, selected a long-term lease, currently have a backlog, are leasing a vehicle, or have a lot of negative equity.
The secret is don’t take the dealership sales spiel for granted. Compare prices, fully understand what is excluded, check if you already have a lease or have a loan, and monitor your loan balance over time. While having GAP is important when you’re underwater, it may be beneficial to attempt to reevaluate your car when you’ve got more equity than loan.