It’s often said that a new car is the worst investment you can make. That’s because a new car depreciates in value the minute you drive it off the lot. If you buy a car for $25,000 and two months later it’s worth $20,000, but you still owe payments on it of $500/month, you owe $2,000 over the original cost.
For most car owners, owing more on your car than it’s worth is just a fact of life. On average, a new car will lose 60% of its value over five years of normal driving. But what happens when your car significantly and immediately depreciates in value as the result of an accident or theft?
Let’s say you just bought a new car and you still owe money on the loan. One day, you’re sitting in a café and you watch someone across the street hit your parked car. Luckily, everyone’s okay–except your car. Your car is totaled and is worth much less than the money you still owe for it on the loan.
That’s where GAP Insurance, or Guaranteed Auto Protection (or Guaranteed Asset Protection), comes into play. Everyone knows about general auto liability insurance and collision insurance. Some people even know about specialty insurance coverage like Classic Car Insurance or Sound System Insurance. But not as many people know about GAP insurance. Let’s explore what GAP insurance is, the importance of GAP insurance, and what the consequences are of not having GAP insurance.
What is GAP Insurance?
GAP insurance is an optional auto insurance coverage that can be added to your current collision insurance policy that may cover the difference between your loan or lease amount due on a new car and what your insurance pays if that car is considered a total covered loss. GAP insurance rates are typically 5% of your annual insurance premium related to your comprehensive and collision coverage.
When you buy a new car, GAP insurance is usually automatically included in your loan. You can often purchase GAP insurance from the dealership, but you should avoid doing so. Dealerships typically hike their rates up 4 times higher than a standard insurance company.
It’s not a legal requirement to purchase GAP insurance, so make sure you have an itemized list of expenses in your loan payment before you authorize the dealership to take out GAP insurance for you. If you’ve just bought a new car, ask your insurance broker instead for a quote on GAP insurance after you’ve secured the new car loan.
Some insurers require you to carry comprehensive and collision insurance coverage in order to qualify for GAP insurance coverage. Always check with your insurance broker to see what requirements are necessary to be eligible for GAP coverage if you need it.
When You Need GAP Insurance
GAP insurance is meant for two types of drivers: those who are financing their cars and those who are leasing their cars. If you own your car, you don’t need GAP insurance. Similarly, if you owe less on your car loan than your car is worth, you also don’t need gap insurance.
If your car is totaled in an accident or stolen and the cash value of the car is less than what you owe on it, you need GAP insurance. Your insurance company won’t pay more than the value of car before damages, which means that if the value of your car falls below your current loan amount, the burden of the expense falls on your shoulders. This discrepancy in value and dues is what’s referred to as “negative equity.”
Let’s say you get a new car and you owe a balance of $30,000 on your loan but the actual cash value of your car is $25,000. It may cost you $30,000 to replace the vehicle, which is why you need GAP insurance. GAP insurance is designed to bridge the negative equity between your vehicle’s value and your loan amount, which is why many drivers consider it to be an agreement of debt cancellation.
If you drive more than 15,000 miles annually, put less than 20 percent down on your vehicle, or purchase a vehicle with a high depreciation rate, you will also want to get GAP insurance.
When You Don’t Need GAP insurance
Once you pay off the loan on your car, you no longer need GAP insurance coverage because GAP insurance coverage only applies to the length of your loan. If you sell your car before the term of your loan has expired, you should still be able to receive a prorated refund on your GAP insurance coverage. In some situations, like owning your vehicle outright, GAP insurance coverage is a waste of money.
If your loan length is short in duration, for example 6 – 12 months, you also don’t need GAP insurance, or can at least forgo it. If your car is worth more than the loan and you know your insurance company’s payout would surpass your loan amount, you don’t need GAP insurance either.
It may also be cheaper to not get GAP insurance if you are still able to make the loan payments after a total loss, or if you know you won’t need to replace your vehicle after a total loss.
Depending on your loan company, you might have a Loan Payoff Benefit included in your loan agreement. This means the loan company will cover the gap in value in the event of a total loss. Some loan and lease agreements also include what’s called a GAP Waiver Provision, which absolves you from having to pay the gap in the event of a total loss. Be sure to go over the terms of your finance contract with the dealership.
Mind the GAP (Insurance)!
The amount of GAP coverage you’re eligible for in the event of an accident or theft varies depending on your policy, and, like your policy, is affected by variables including your credit score, credit history, employment, driving history, and more.
If you’re leasing or financing your car, GAP insurance is vital. If not, you don’t need it. The extra monthly premium to get GAP nsurance can seem like a headache, but if you’re leasing or financing your vehicle, it’s imperative you contact a FrontLight Insurance broker and ensure you have the GAP coverage you need in a worst-case scenario. Don’t get caught paying off a car loan for a car you can’t drive.