Gap Insurance – Do I Need It?

Insurance is rarely anyone’s favorite expenditure, so the idea of spending more hard-earned cash on yet another type of coverage is not generally met with enthusiasm, especially as few people have even heard of gap insurance. So what exactly is gap insurance, and do you really need it if you already have car insurance?

Gap insurance is an abbreviation for Guaranteed Asset Protection coverage. It does exactly what the name suggests—it insures the gap between what an insurance policy would pay out in the event of a claim and the total amount of finance left owing on the vehicle.

The minute a vehicle is driven out of the showroom, thousands of dollars are wiped off its value. Should you be unlucky enough to be in an accident as you drive away, you could be facing a significant financial loss. Your auto insurance would pay out the market value of your car, but that may be substantially less than the finance you owe. Gap insurance is designed to cover the difference. Many types of gap insurance also include a range of extras such as theft cover.

Despite the fact that a new vehicle immediately depreciates in value, there is no denying the attraction of buying a car straight off the factory floor, knowing that no-one else has owned it. Although it may make far better financial sense to buy near-new, where the downward curve in value is steadier having already gone through its initial drop, the appeal of a brand new purchase is obvious.

However, having made the decision to buy a brand new vehicle, it is preferable not to have to finance the whole purchase. While 100% deals are available, it creates what is known as an ‘upside down’ position—essentially negative equity for vehicles. Financing all or a substantial proportion of the purchase means that for a considerable length of time you will be paying for something which is worth less than what you owe on it.

Economically, it is best to have at least a 20% deposit on a vehicle. In an ideal world you would be able to buy it outright in cash. Realistically however, very few Americans have this kind of money, particularly in the current financial climate.

Given the potential risks, those that opt to buy a new car using finance should seriously consider gap insurance, unless there is money available to pay off the remaining loan balance if the worst should happen. Remember that if an accident occurs, the auto insurance provider will, at best, pay the market value of the auto. Not only may this be less than the finance balance but it may in fact be well below the purchase price.

In general terms, the difference between the market value and purchase price is in the region of 20%-30%. This means that you could be left making monthly repayments on a vehicle you no longer have, with the added expense of funding a replacement. This is where gap insurance is at its most useful, covering the difference on the original vehicle. This would remove the need to continue with repayments, leaving you free to go and find another car.

However, once you have been making finance repayments for some time, there comes a point at which there is little or no difference between what the auto insurance would cover and the remaining finance balance. By this time, gap insurance has limited value and becomes an unnecessary expense. It is therefore worth keeping this in mind and periodically checking the market value against the finance balance. A reputable source such as the Kelley Blue Book can help provide a guide as to the likely market value.

Gap insurance is not just helpful for those purchasing a brand new car. Anyone buying a relatively late model vehicle could still find themselves ‘upside down’ on their loan if they finance all or most of it. Admittedly, the situation is unlikely to be quite as severe as for those purchasing brand new but there is still likely to be a difference, certainly for the early part of any finance deal. In some cases it can be rather borderline for used vehicles so it makes good sense to balance off the cost of paying for gap insurance against the likely difference in value between the market value and the amount financed.

Gap insurance is also a good idea if you are considering leasing a vehicle as the same principles apply, even though the car is not legally your property. In many states, leasing companies will insist you provide evidence of gap insurance before supplying you with a vehicle.

Any driver who is in a situation where the vehicle is likely to depreciate more rapidly than most is also a good candidate for gap insurance. The most common example of this scenario would be some-one who covers a lot of miles; insurance valuations tend to penalize high mileage heavily in the event of a claim.

Some auto insurance policies automatically include gap insurance in the plan so there is no need to obtain separate coverage. However, this is by no means standard for all providers so it is worth checking first before dismissing it.

If you are buying from a dealer they will probably try to sell you gap insurance. Many people opt to buy it this way for convenience and the peace of mind knowing they are covered the minute they leave the showroom. However, gap insurance does not have to be purchased this way and is unlikely to offer the best coverage or lowest premium. The easiest way to find a suitable policy is by searching on the internet – there are many providers and this should allow you to compare the features of each policy and get the best deal without paying a high price for convenience.

If gap insurance seems to be a good idea, it is worth knowing that not all policies are created equal. Some factors to consider include whether there is any financial limit on the gap, whether the auto insurance deductible will also be covered and whether the coverage provides any assistance in purchasing a new vehicle. Some types of gap insurance include a down payment on the next purchase as an additional benefit, although this may require you to return to the same dealer. Some gap insurance policies will provide more comprehensive coverage than others, for example including cases where the car was stolen with the keys as well as covering regular theft.