How does GAP insurance Work: Everything you need to know
In this article, we’ll go over everything you need to know about GAP insurance and some surprising facts and statistics for these contracts. We’ll cover:
What is GAP Insurance
How does GAP insurance work
How much does GAP insurance cover
Who should get GAP insurance
Who is the best provider of GAP insurance
How do I cancel GAP insurance
Are there other ways to save money on my car
What is GAP insurance?
GAP insurance is a type of auto insurance that technically stands for “Guaranteed Asset Protection” insurance, but the name itself doesn’t clarify what is actually being insured. GAP covers the difference between the amount you owe on an existing car loan or lease and the amount an insurer will pay in a total loss claim.
Let’s go through this in plain English. If you are in a car accident the damage incurred on the car exceeds the value, then your auto insurance company will offer you a fair-value payout for your car, or they’ll “total the car”. Sometimes however, the fair-value of the vehicle is below the amount you might owe on the lease or vehicle loan. So if your car insurance policy is only willing to $10,000 through your existing collision coverage and you still owe $12,000 on the vehicle, GAP insurance will pay this difference.
How does GAP Insurance Work?
GAP insurance is a strange concept in many ways. Many consumers believe that their car's value closely tracks how they pay down their loan (e.g. so although my loan payments are $250 per month, my car is declining in value at about the same rate).
Unfortunately - the amount you pay per month has little to do with the depreciation of the car. Instead, a vehicle’s depreciation is highest in the beginning of the ownership period, and yet your payments are linear throughout this time. A brand new car immediately becomes a used car, and so depreciation is particularly high for new vehicles. As a simple rule of thumb, your need for GAP coverage is typically highest the MINUTE you drive off the dealership lot. Let’s take an example below:
If you purchase a car for $25,000 here’s how the depreciation versus the loan balance might look.
(This assumes 5% tax and registration fee, 10% APR loan over 72 months, and no downpayment. Depreciation curves are taken from Nerdwallet who uses NADA values)
The table and the chart above show how GAP coverage changes throughout the car's lifetime. As you can see, GAP insurance is MOST valuable in the beginning of the loan when the car is rapidly depreciating AND the payments on the loan are going mostly towards interest rather than principle.
If a vehicle owner had a total loss collision in month 12 for example - then the actual cash value of the car might only be $18,750 but the owner would still be liable for paying down a $22,888 loan balance. If the owner had GAP insurance, then the car insurance provider would pay the lienholder or lender the additional $4,138 difference.
It should be noted that car insurance companies might use a variety of methods to determine the vehicle's actual cash value. Some providers will use standardized book values (such as NADA, Kelley Blue Book, or Black Book) to determine market value. In these cases where a "book value" is used, be sure that your insurance company has all of the details of your vehicle to accurately determine the value of your car. They need to know the options, packages, and correct trim level for your totaled car. In other cases your insurance company may look at comparable listings for sale from private parties or dealerships.
Let’s say you have had an accident, and find yourself needing to utilize your GAP insurance. Here’s an easy process to utilize your insurance:
Step 1: Locate the GAP insurance provider and the policy number. If you received GAP insurance policy through your insurance company this process is straightforward. If you purchased GAP insurance through the dealership, often your original purchase contract or the dealership itself will have details on both your Provider and the Policy Number.
Step 2: Call the GAP insurance company with details of the accident. Normally you’ll need to submit proof of the total loss (e.g. records from your insurance company), and inform them of the lienholder (lender) and account number of your loan. Often you’ll need to provide record of the 10 day payoff statement to the GAP insurance provider. Other times your lender MAY also be able to reach your GAP provider and handle these logistics for you - so it’s worth calling your bank as well.
Step 3: Ensure the lienholder has been paid! Although GAP covers this loan balance difference, it's your responsibility to ensure the lender has been paid, otherwise it impacts your credit! After coordinating the GAP insurer and the lender make sure that the loan balance truly is 0.
How Much Does GAP Insurance Cover?
GAP insurance most of the time has very simple coverage: The difference between your insurance total loss payout and the existing loan balance.
It does NOT cover:
Rental car reimbursement
Aftermarket parts coverage or modifications to your car
Any expenses incurred that are NOT part of the vehicle loan
In some cases, also make sure that GAP insurance DOES cover your insurance deductible (not all GAP policies do) so in the event of a total loss you minimize your total out of pocket expenses. Check with your car insurance provider
Who Should get GAP Insurance and do I need GAP Insurance?
The internet is filled with myths on “who should” get GAP insurance and why. Here’s some quick internet myths:
Internet Myths for who should get GAP insurance coverage:
The length of the loan is 5 years (60 months) or more
The interest rate on the loan is high (7% or more)
The total downpayment on the vehicle is high
Unfortunately the advice should be a little more nuanced. We believe you should only get GAP insurance if all of these statements are true:
Having to pay out of pocket for a Total Loss event would cause undue financial stress.
If you can’t handle paying a $2,500 bill to your lienholder and this would cause a large financial burden, then insurance can be worthwhile.
Your loan balance is materially higher than equity value of the car:
If you purchased a rapidly depreciating car such as a brand new vehicle, a luxury vehicle, or put very high miles on the car (these all accelerate depreciation).
If you rolled “negative equity” from a previous trade-in into the loan (this is also called being "upside down" on your old trade-in).
If you have a high interest rate on the loan (10%+)
Your lender won’t forgive negative equity upon total-loss.
Believe it or not some lenders forgive negative equity balances in the event of total losses. For some subprime (FICO < 580) loans, it's not worth the lenders time to pursue the customer for a car that’s no longer useful to the customer, and so they simply forgive the remaining loan amount. Please note - most lenders will not tell you that they have this policy internally, so it's useful to ask but sometimes very hard to find this information.
If you don't meet these guidelines, then it's unlikely that gap insurance worth it.
Where should I buy GAP Insurance?
Luckily, our recommendation for where to buy GAP insurance is very easy.
Don’t get it at the dealership
Get it anywhere else and you’ll end up with a much better deal
The car dealership is the most convenient way to buy GAP insurance (and they’ll likely be the first to educate and offer it to you). Buying from the dealership is the worst possible option because:
They are just a reseller themselves, so you’ll be paying additional margin on the insurance contract. Dealerships are likely to markup the GAP contract by 100% or more, and treat GAP like any other product add-on they can stuff into your car payments.
They’ll likely put the GAP insurance into the loan agreement, and so you’ll be paying interest on the GAP insurance in each car payment.
Getting a third party GAP contact often makes the process of being reimbursed in a total loss LESS convenient since you'll need to coordinate your GAP provider, your collision insurance, and your loan or lease company.
If not from the dealership where should you buy gap?
Most insurance companies offer a GAP insurance or similar product. Call and ask your existing auto insurance coverage provider - most the time the costs is only incurred monthly, and it's also cancellable at any time.
There are a number of speciality GAP insurers where you can purchase gap directly from the provider. Here’s a brief list of vendors below:
Providers who offer GAP independently:
How do I cancel GAP insurance
For many consumers - GAP insurance is worthless. This is because the value of the car already exceeds the balance of the loan. If we look at the curve from before:
There is no longer any value to GAP insurance past month 46 or so. This is for a vehicle with high interest and no payment, so imagine how quickly GAP could become worthless for low-interest loans. Furthermore, in many cases consumers have purchased GAP contracts directly from the dealership. In these cases the GAP insurance covers the entire life of the loan (often for 72 months).
The good news: You can cancel GAP at anytime and be reimbursed for the remaining payments. So let’s say you cancel your GAP contract that you paid $1000 for half-way through the loan. You will received a $500 refund.
To do so:
Locate your GAP policy provider. This is typically done by looking at your original sales contract. If you can’t locate the sales contract, locate the dealership where you originally purchased the vehicle.
Locate your GAP policy number. Once you’ve located the provider, this same original contract should also contain details on the GAP policy number (much the same as an insurance policy). If you can’t locate it, you should be able to call your GAP provider and provide your personal details and the vehicle’s VIN number to locate the policy number.
Call the GAP provider by googling the provider, or asking the dealership to provide you with the GAP providers phone number. When you speak with someone you’ll need to give them the policy number and request that you cancel the GAP contract and would like a pro-rated refund.
If I can cancel GAP insurance and get savings are there other ways to save money?
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