Gap insurance: everything you need to know
This gap insurance guide explains gap insurance thoroughly and should help you answer the question: Is gap insurance worth it?
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Gap covers the difference between your auto loan balance and the car's cash value in the event of a total loss.
It's not uncommon today for consumers to buy cars with little or no down payment, then drive off in a vehicle that's worth less than its loan balance. However, if your car meets its maker prematurely, your comprehensive or collision insurance reimbursement is based on the vehicle's cash value, not your loan balance. You could end up with no car, no way of purchasing another car, and a balance owed to your auto lender. Gap insurance is designed to pick up that balance.
Gap stands for Guaranteed Asset Protection, and it kicks in when:
- An insured vehicle is stolen or totaled.
- The insured vehicle has comprehensive insurance coverage up to the car's cash value.
- The insured vehicle owner has paid for gap insurance.
Gap works when your car is declared a total loss, either due to a wreck or theft of your vehicle.
This illustrates where gap fits into your insurance protections:
- Your insured car may have a cash value of $5,000
- Assume the amount owed on your auto loan is $6,000.
- An accident renders your car a complete loss.
- After your deductible, your comprehensive or collision insurance should cover the cash value of your vehicle, or $5,000.
- Your gap coverage should provide the $1,000 needed to pay off your auto loan.
Note: Gap insurance doesn't apply a deductible and some gap policies provide reimbursement of your comprehensive or collision deductible.
Gap insurance does not make up missed payments and late fees if you lose your job, if you need a rental car, or if your car is repossessed. A summary of items typically not covered by gap insurance include:
- Items purchased with the auto loan, such as extended warranties or credit life insurance.
- The unused balance of an extended warranty.
- Any balances from prior loans.
- Lease or loan security deposits.
- Any equipment that you added to your car beyond what was factory-installed.
- Past due loan or lease payments.
- Lease penalties for excessive mileage.
- Deductions made by your primary insurer for previous damage, towing, storage and/or wear and tear.
- Any other losses that are excluded from your auto insurance policy.
When you purchase gap insurance, make sure you know exactly what is covered and what is not covered, because not all policies are alike.
You may need gap if your car is "upside down." Being "upside down" means your loan balance exceeds your vehicle's value, and it happens for these reasons:
- Most cars begin to lose value the second the ink dries and they morph from "new" to "used."
- Auto buyers are allowed to buy cars with smaller down payments, or even no down payments.
- Some manufacturers let buyers make no payments for an introductory period, while the car depreciates.
- Dealerships may take trade-ins that are "upside down" and add the deficiency to the new car loan.
- Buyers may wrap purchasing costs, such as transfer fees or extended warranties, into their loans.
- Today's auto loans are available with much longer terms, with the average nearing six years. It can take years to pay the balance down below the car's cash value. The average auto loan length is now 69.5 months compared with 65.7 months five years ago, or about a 7 percent increase, according to Edmunds.com.
- Prices are increasing -- the average price paid for a new car is $34,623, compared with $31,078 five years ago, according to Edmunds.com.
These trends increase the odds that your car may lose value faster than you can pay down its loan balance. That can leave you in a financially risky position.
When deciding how much coverage you need, think "worst case." If you wreck your new car on your way home from the dealership, how much will you owe, and what's your car's cash value? If you could write a check for the difference without even checking your balance, you probably don't need gap. But if any of these statements are true, consider buying gap insurance coverage:
- Your vehicle is leased.
- Your down payment is less than 20 percent of the car's value.
- Your trade-in was upside down (i.e. had a loan balance above the vehicle's value).
- You drive more than most people, causing the car to lose value faster.*
- Your auto loan's term exceeds 48 months.
- You bought a model that depreciates quickly.
*According to the Department of Transportation, the average driver puts 13,476 miles on his or her car annually. Men drive more than women, averaging 16,550 miles a year, compared to 10,142 miles for women. If you rack up more miles annually than the average driver, your car is likely to depreciate faster than it would otherwise.
Over time, your auto loan balance should diminish. How quickly this happens depends on your loan amount, interest rate and term. For example, the graph below shows the amortization of a $35,000 60-month auto loan at 7 percent interest with a payment of $693.04. The blue line shows the car depreciating at a "typical" rate according to Consumer Reports, while the orange line indicates the loan's declining balance.
Notice that during the second year, the typical car's depreciation rate has leveled off somewhat, and the auto loan balance has dropped below the car's value. This illustrates why you should not just "set and forget" your auto insurance when you buy your car. "At a certain point, you might be able cover the gap with your savings. And once you're in positive territory on the loan, gap coverage may be a waste of money," says Penny Gusner, Consumer Analyst at Insure.com.
Structuring your purchase to eliminate the need for gap reduces both your financing and insurance costs. Keep these tips in mind when you go car shopping.
- Resist loans with longer terms. Auto salespeople love to get you talking payment instead of price, but that makes it easier for you to forget how much you're actually spending. If you can't afford the payment with a 48-month loan, negotiate a lower price or choose a cheaper car.
- Avoid excess depreciation. Some cars hold onto their values much more effectively than others. For example, the 2014 Chevy Captiva sport is expected to lose 62 percent of its value in 36 months, while its rival, the Subaru Impreza, will likely lose just 38.7 percent of its value. You can compare resale values on sites like Kelley Blue Book or the National Automobile Dealers Association (NADA).
- Put at least 20 percent down, even if you qualify to finance more. You can avoid the need for gap and secure a lower payment, too.
- Don't roll other charges into your auto loan. If you finance taxes, licensing, and registration, you pile on a lot of financing unrelated to the car's value. If you include purchasing costs or dealer packages like service plans and extended warranties, make sure your gap insurance covers them, because some won't.
You can't buy gap unless you also have comprehensive and collision insurance. Gap picks up where they leave off. Generally, you have 12 months after purchasing a vehicle to add gap insurance to your policy. If you are buying a new car and expect to be "upside down" from the perspective of cash value to loan value as soon as you leave the lot, you may consider buying gap insurance as soon as possible.
Call an Insurance.com licensed agent at 844-285-6112 to compare auto insurance quotes from multiple carriers.
You may be able to get the additional coverage from your current auto insurer, your dealer, or another company. Below is a partial list of gap insurance companies:
Gap insurance companies
Gap insurance is fairly inexpensive, about $41 a year, or about a 3 percent increase on your insurance premium, according to an Insurance.com analysis of rates from up to six major insurers for 10 ZIP codes in each state. However, all gap policies are not exactly alike, and covering extras, such as warranties that are rolled into your auto loan, cost more.
Although it may be the most convenient option, purchasing gap from your dealer is probably the most expensive way to get it.
Attorney Steve Lehto of lehtoslaw.com says, "One big problem with gap from a dealer is that the dealer gets a slice for selling it and the slice is often whatever the dealer feels like profiting. That is, the insurer simply says, 'As long as we get $300 for this, you can mark it up as much as you like.' So the policy could then be $399 ($99 profit) or $999 ($699 profit). These things are negotiable. Anyone who pays the asking price for gap at a dealer is a sucker. At the very least, call your own agent and get a competitive bid."
There can, however, be an advantage in buying gap insurance through a dealer. "Sometimes the dealer coverage will pay off a portion of the loan, which was rolled in from a previous loan," notes Lehto. "Whereas gap coverage from a typical insurer only covers the loan payoff attributable to the car's purchase price."
Used car loan terms are usually shorter than new car loans, and down payment requirements are often higher, so you might not be upside down when you drive off the lot. However, you should apply the same decision-making logic to your new-to-you car, because if it is upside down and you can't just whip out your checkbook and pay it off, an accident could wreck not just your car but also your finances.
Your gap coverage will almost always be canceled automatically if you refinance your auto loan. Depending on the provider and the elapsed time since you bought the coverage, you may be entitled to a refund. If you're rolling negative equity into the new auto loan, consider adding gap coverage until your loan balance drops below the car's value.
"The vehicle's depreciation rate, your financial situation, your down payment amount and the specific insurance policy coverage all contribute to your decision," explains Nancy Smeltzer, a spokeswoman for Nationwide.
"A comparison of the vehicle's current value with any unpaid amount due on the loan or lease is a great place to start," she says. "Your insurance agent can also assist by reviewing those values with you and helping to determine how long you should maintain gap coverage."
Comparing gap to lease/loan coverage
Both gap insurance and lease/loan insurance help to cover the difference between your vehicle's cash value and the amount you still owe on its loan or lease, in the event of a total loss. The main difference between the two insurance types is that lease/loan coverage generally stipulates a limit on what benefit is available, generally as a percentage of your vehicle's value.
According to esurance, lease/loan insurance often pays about 25 percent of your vehicle's actual cash value. Depending upon where you are in your loan repayment process and how that compares to your vehicle's cash value, this may or may not be enough to cover your remaining loan or lease value in the event of a complete loss.
For example, if your car is worth $25,000 and your lease/loan coverage pays up to 25 percent of your vehicle's worth, the maximum payout in the event of a total loss would be $6,250. During the early part of your loan, this coverage amount may not provide complete protection to you.
Comparing gap to new car replacement insurance
Gap insurance coverage is designed to protect you if your car is a total loss by making up the difference between the auto loan balance and the car's cash value.
New car replacement coverage is different. It covers the difference between the car's cash value and the cost of purchasing that exact car again, new. When you drive a new car off the lot, it officially becomes a "used" car, and loses value immediately. If you total your new car while colliding with a boulder on your way home from the dealership, the car's cash value would be less than the cost of replacing it. Replacement coverage would make up the difference, allowing you to buy another car exactly like the one you totaled.
However, this has nothing to do with your loan amount. If your loan balance exceeds the car's replacement value, you'll still have to pay your lender unless you have gap insurance. The illustration below shows what happens when you total your car with gap insurance.
If the cost to replace your car is higher than your loan balance, it may be best to have new car replacement coverage. The illustration below differs from the one above in that the replacement cost is higher than the loan balance.
The comparison between gap and new car replacement depends on the loan balance and the car's depreciation rate. If your loan amount exceeds the car's purchase price, gap insurance should pay more. If the loan is less than the car's replacement price, new car replacement may pay more.