Guaranteed Auto Protection, or Gap Insurance, is a type of car insurance used to cover the difference between the actual cash value of a vehicle and the balance that is still owed on the financing. People who buy GAP insurance typically do so to cover used and new small vehicles and heavy trucks. In some cases, financing companies will require the car owner to have a policy in place.
What is the GAP?
In an article posted by NOLO Law that addresses the question of whether or not GAP insurance is necessary. The article explains the concept of negative equity defining it as:
When your car is worth less than what you owe on it- it puts car buyers and lessees at risk because an auto insurance policy won’t pay out more for repairs or replacement than the auto is worth.
The article uses the example of a $25,000 auto loan for five years with a six percent interest rate. After one year of payments, the loan’s balance is $20,580. At the time of loss (major accident that totals the car) the actual car’s value is $19,000. The car insurance policy as a $500 deductible and the insurance company will pay $18,500 based on its value minus the deductible. The problem for the car owner is that they still owe an additional $2,080 on the car loan. This remaining balance is known as the gap. The GAP begins as soon as the car is driven off the lot due to a number of factors including depreciation of a vehicle. Cars lose value the more they are driven and the more they are exposed to bad road and weather conditions. Some estimates show that cars can lose up to 30 percent of their value within the first three months. In addition to depreciation, the GAP can also grow as a result of an extended term car loan. Extended term loans have their obvious advantages. They lower your monthly payments, but because of this the car owner grows equity at a much slower rate. This results in the car losing value at a much greater rate than you are paying off the car, making the gap larger. If the driver takes out a loan for a huge majority of the vehicle’s price, not putting very much (if any) money down, then the gap exists as soon as you drive home because a car becomes used immediately. If you not only borrow enough for the car itself, but also for the tax, license, registration, extended warranties then you leave yourself with a gap immediately.
How the insurance policy works?
Now that you know what the GAP is when it comes to car financing it is also important to understand how the GAP insurance will work. In the linked article, the example is given of a person who purchases a brand new car, only to get into a major accident that totals the vehicle. We all know that cars lose value as soon as they are driven off the lot, but when they are damaged to the point where no repair can save the vehicle the value drops to the ground because there is not much that can be salvaged. Chances are out a loan to purchase the vehicle and unless you want to take some of the salvaged pieces to the scrap yard to see if you can make enough to make payments, then you will want to purchase GAP insurance. Without it, the driver will be responsible for continuing to make payments on the outstanding auto loan. That leaves the driver in a tough spot. If they are paying for a car they are no longer able to drive, chances are they are going to have trouble purchasing another vehicle to get them to where they need to go. Now if the driver had a GAP insurance policy in place, this dilemma would not exist. After the accident, the driver would simply call the local independent insurance agent that they purchased the GAP insurance policy from and they would be helped through the process of filing a claim. Then the insurance will cover the cost that you still owe on the vehicle, allowing you to purchase another vehicle and not have to pay for a car that is being crushed in a junkyard car crusher.
What does GAP insurance not cover?
Fox Business addresses the myth that GAP insurance covers payments whenever someone is unable to make their payments. There are things that Gap insurance does not cover, including the following:
- Car payments in the case of financial hardship
- Car repairs
- The value of your car or balance of a loan if a vehicle is repossessed
- A rental car while your vehicle is in the shop
- The diminished value of your car after an accident
- A down payment on a new car
- Carry-over balances on any other loans rolled over at the time of your car purchase
- Extended warranties added to your car loan
Is it right for me?
As a general rule of thumb, if you are financing a vehicle, GAP insurance is probably the safest buy that you can make. It will cover you in the case of an accident that leaves your vehicle unrepairable. It is especially useful for those who are taking out an extended loan of five years or more, taking out a loan with a high interest rate, new vehicles with a low down payment or if you are leasing a vehicle. If you are doing any of these things, chances are you are not in a position to be able to afford to pay off a loan if your car is totaled and you definitely are not going to be able to afford doing this while financing another vehicle to get you to work each day. If this is the case than GAP insurance is for you. Now if you are making a large down payment on a car or you have a loan that will be paid off in three years or less then you do not need GAP insurance coverage. If you work hard and are financially able to owe little to nothing on your new vehicle then more power to you. If you do not have a car loan then you do not need GAP insurance. If you owe less on your vehicle than the value of the car itself, then there is no GAP to cover and you will want to contact your local independent auto insurance agent to cancel you GAP insurance coverage.
What to look for when purchasing a GAP insurance policy
Bankrate offers some great tips when it comes to shopping for GAP insurance coverage. The first tip they give is to contact your insurance agent. Contacting your local independent auto insurance agent is very important when looking for GAP insurance coverage. Some standard auto insurance policies have GAP insurance included, while others may have it as an add-on. Depending on the state you live in, there may also be a requirement for auto insurance companies to include GAP insurance on all new car purchases. Having all of your insurance coverage in one place is helpful when it comes to making payments and claims. If you work with your independent auto insurance agent when purchasing a GAP insurance policy, then the process is simplified. In the event of an accident you can file two claims at once (your GAP insurance claim and your standard auto insurance claim) at once, without having to go through two separate firms. Car dealerships will often offer customers GAP insurance coverage when purchasing a new car, adding the insurance cost into the monthly payment plan for car payments. The issue with this is that the car dealership often does this to not only protect themselves in the event that the customer is unable to make their payments, but also to make a few extra dollars on the insurance costs. GAP insurance coverage is often higher through a dealership than it is through an independent auto insurance agent. Always contact your insurance agent before taking an insurance policy from the dealership itself. Just like any other insurance policy, it is important to review the deductible of a GAP insurance policy. GAP insurance will not be needed for the entire period of your car loan. It is only needed when you owe more on the vehicle than the vehicle is worth. Eventually the scale should shift to where you owe less than it is worth and then you owe nothing at all. Typically GAP insurance is needed for three years. Deductibles on GAP insurance can be higher than primary car insurance deductibles because it is meant to cover a totaled vehicle more than anything else. Each insurance company may have different exclusions with their GAP insurance. Some policies may cover the cost beyond the GAP, such as making overdue lease or loan payments and paying carry-over balance from a previous car that was rolled into a new car loan. Some may even pa for the cost of an extended warranty purchased at the time of the car. When people lease a car, the GAP polices may reimburse security deposits and pay any penalties assessed for mileage or wear and tear of the vehicle. Now the GAP is definition can also vary a bit from policy to policy. Some policies pay the price difference between the car’s value at the time it was totaled in a crash and the amount that you owe on your loan regardless of the amount. Other policies may set limits on the coverage to a certain amount or percentage. It is important to understand what restrictions your GAP insurance policy has before purchasing, making it important to contact a local independent auto insurance agent to give you list of options.
What does GAP insurance cost?
GAP insurance premiums are roughly five to six percent of the premium costs for collision and comprehensive insurance you already have on your vehicle, according to Bankrate. This means that if you spend an annual amount of $1,400 on your car insurance premium with $420 to $560 on collision and comprehensive coverage, the GAP insurance will cost only $20 to $30. The cost also will go down along with the collision and comprehensive as the vehicle ages. This is an important cost to keep in mind, because car dealerships that offer GAP insurance often charge double that. This cost is very affordable when you think about the example of negative equity listed above. With a $25,000 car loan and an insurance policy that will only cover the $19,000 that the car is worth after a year, it will leave you with more than $2,000 to pay out of pocket to cover the gap of the car loan. Though you may pay off your vehicle without ever having to file a GAP insurance claim, having the safety net to fall into if you do get into a major accident is a great route to go when financing a vehicle. Not available in every state!
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