Introduction
Buying a car it is very important to get the right insurance. There is one term which is frequently mentioned while discussing car financing and it is gap insurance. This extra layer of coverage may not be necessary when obtaining a car loan, but it can help you avoid major losses in the event of a total loss of your car or its theft. However, many borrowers are in a position to know whether gap insurance is worth the extra charge.
This is the reason why at Automatic Car Credit we make sure that every buyer is fully informed of his choices. In this article, we’ll take a look at what gap insurance is, how it functions, and whether or not it is the best option for you when purchasing a car.
What is Gap Insurance?
Guaranteed Asset Protection or GAP is an insurance product which reimburses the difference between the actual cash value of the car at the time of total loss and the outstanding loan balance in case the car is stolen or wrecked.
It is common knowledge that cars lose their value very fast, particularly within the initial years of ownership. Sadly, this means that the car’s market value may be lower than the amount you borrowed for the car loan. In such instances, gap insurance can fill that “gap,” so that you are not legally liable for paying off a loan on a car that you no longer own.
What is Gap Insurance and How does it work?
- Suppose you purchased a car for $30000 and borrowed $25000 for the purchase and after one year of owning the car you still have $23000 to pay.
- However, due to depreciation, the actual cash value of the vehicle as at the time of the accident or theft is only $18,000.
- Your first car insurance would cover the actual cash value of the car if it is a total loss or stolen, in this case, $18,000. This means there will be a $5,000 difference between what you receive and the amount you still have to pay on the loan.
If you don’t have gap insurance, you are the one who would have to pay that $5,000 out of pocket. But if you have gap insurance, then it would pay the remaining balance and you would be free of any debt.
Who Should Consider Gap Insurance?
- New Car Buyers
Cars lose value the moment they are driven off the lot, with most vehicles depreciating by 20-30% in their first year alone. If you’ve purchased a brand-new car, you may owe more on your loan than the car is worth for the first few years of ownership. In this case, gap insurance is a wise investment to protect yourself against the financial risk of a total loss.
- Low Down Payment or Zero Down Payment
If you’ve financed your car with little to no down payment, there’s a good chance that you owe more on the loan than the car is worth. Without a substantial down payment, you could easily end up “upside down” on your loan, where the balance you owe is higher than the vehicle’s actual cash value. Gap insurance can provide peace of mind if you fall into this category.
- Long-Term Loans
Many buyers opt for long-term auto loans of 60, 72, or even 84 months to lower their monthly payments. However, these extended loan terms can increase the likelihood of being upside down on your loan for a longer period. In this situation, gap insurance can protect you from having to pay off the balance if something happens to the car during the early years of the loan.
- High-Interest Loans
For borrowers with bad credit, car loans often come with higher interest rates. This can slow the rate at which you pay off the principal on your loan, leaving you with a higher balance compared to the car’s depreciating value. If you’re paying a high interest rate, gap insurance can help protect you in case of a total loss before you’ve had a chance to pay down your loan significantly.
The Cost of Gap Insurance
It is also important to note that there are different ways through which you can buy gap insurance and as such, the cost may vary. Gap insurance can be purchased from the car dealership, your auto finance company or from your insurance provider.
- Dealerships:
When purchasing gap insurance from the dealership, the cost is between $400 and $700, and is rolled into the loan, meaning that you pay in monthly installments.
- Insurance Companies:
Most car insurance companies also have gap insurance as a part of your coverage and this is cheaper, costing between $20 and $40 per year.
On the one hand, the cost is low compared to the possible loss in case of being upside down on a loan, yet it is also important to look for various offers and choose the most suitable gap insurance policy.
Should You Get Gap Insurance?
The desirability of gap insurance in a given case depends on the ability of the car owner to afford the insurance and their tolerance to risk. Here are some questions to consider when making your decision:
- How fast does your car lose its value?
Different cars depreciate at different rates and therefore it is important to find out how fast your particular make and model is likely to depreciate.
- What is the balance on your loan?
If you are in the position of owing more than the car is worth, then gap insurance can be a life saver as it can save you thousands of dollars.
- Is the difference too much for you to pay out of your pocket?
If for instance your car is a total wreck, would you be in a position to pay the difference between the insurance settlement and the loan amount?
Bottom Line
This is why gap insurance is very useful for borrowers who are likely to be caught up in upside-down car loans. Whether it is worthwhile or not depends on a number of factors including your financial situation and the structure of the loan. To most especially those with new cars, long term loans, or low down payments, gap insurance provides the much needed cover and assurance. At Automatic Car Credit, we always advise any borrower to take his or her time and look at all aspects before coming to a decision.
Ultimately, while gap insurance isn’t always necessary, it can be a financial lifesaver in the unfortunate event of an accident or theft.