What is GAP Insurance, and is it Necessary?
For most drivers a regular insurance policy is enough to cover the car in an accident. However, if you owe more than the car is worth you might consider Gap insurance, or what is more commonly called “GAP Protection”.
GAP is protection against negative equity on your car, especially at the beginning of the car loan. Let me explain how this could be something you would want, or if it is a complete waste of your hard earned money.
When you buy a new or used car you typically put some money as a down payment. How much to put down is different on all cars. Typically taxes, license, registration and any extended warranties or service plans that you might buy will be added to the final price of the car purchase. If you were to finance the total amount, including those fees, you would be financing more than the car is technically worth and you would be upside-down on your loan.
The danger is that you will owe more on the loan than the car is worth. If you were to encounter a total loss (by theft or accident) the insurance will only pay you what the car is worth and not what you actually owe. GAP protection is insurance that covers the difference of what you “owe” on the car and what it is “worth” so that you do not go out of pocket in the event of this total loss.
GAP insurance would only be important if your car loan is more than the value of the car. The problem is that the finance person at the dealership (who is handling all the paperwork at the end of the deal) can make some additional money by selling you GAP even though there would be no use for it. Not understanding how GAP works leaves you vulnerable to this additional profit for the dealer. It happens a lot, and for many people GAP is a waste of money.
Here is a graph I prepared that shows the value of the car and how much you may still owe.
Below are a few circumstances where it is prudent to purchase GAP insurance:
- Longer term loans
Taking out a loan beyond 60 months will give you lower payments but it also means that you will not have equity in the car for a very long time.
- Heavy Depreciation
All cars depreciate. However there are some cars that depreciate much more than others. A few examples would be any high-end luxury cars such as Mercedes, BMW and Lexus. With these cars you will need as much as 30% down to avoid needing GAP.
- Not enough as a down payment
Financing all, or nearly all of the car purchase will instantly put you upside down on the loan. This is especially true of a new car purchase where the depreciation is very high. As soon as you drive off the lot it becomes a “used” car. With most cars 20% as a down payment will be sufficient to avoid GAP.
- Borrowing more than the car is worth
If you include the tax, license, and registration in your loan you will be borrowing more than the car is worth. Extras such as a warranty or an extended service plan will exaggerate the loan and you will very quickly owe more than the cars value.
How much Should you Pay for GAP Insurance?
I have seen it as low as $295 and as high as $995. It depends on the type of car and how much exposure you have with the loan. Typically I would negotiate on any amount over $395-$495 for the average car purchase.
Getting a Refund on GAP
If you do purchase GAP you should seriously cancel the GAP (and get some of your money back) at the point in your loan when you are in an equity position on the car. GAP is usually refundable with whatever time you have left remaining on the loan. This could be several hundred dollars in your pocket. The dealers really don’t want you to know that, but I do.
Greg Macke- Your Car Angel
Greg Macke is a car blogger and author of “My 7 Secrets to Buying a High Quality Used Car”. He is a professional car buyer and consumer advocate working closely in the industry to improve the buyer’s experience. His high quality car buying tutorials offer help to the car buying public. – See more at: http://yourcarangel.com/
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