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What Is GAP Insurance for Cars and Why Should You Buy It?

mindthegap2Many years ago, I worked with an old engineer who always wore a belt and suspenders. Always. One day I pointed out that fashion snobs consider a belt and suspenders to be a serious sartorial faux pas.

He was unimpressed.

“I know,” he said, “But I’m allergic to risk.” That remained a running joke between us until he retired a few years later.

Some people believe that guaranteed asset protection (GAP) insurance is overkill too, but that’s not necessarily true.

What is GAP Insurance?

GAP insurance covers the difference between what you owe on your car and what your insurance company would pay if you get in an accident and your vehicle is declared a total loss.

Usually, when you get in an accident and your car is declared a total loss — or your car is stolen and never found — your auto insurance company pays the car’s blue book value minus your policy’s deductible.

Of course, there’s a catch: If the car’s loan or lease balance is more than the market value of the vehicle, then you are on the hook for the difference; it’s a scenario that’s typically — but not always — more common early in the life of a new car. For example, according to Edmunds, a brand new Nissan 370z loses 9% of its total market value in the very first minute it’s driven off the lot; after one year, it’s 19%.

So, with that in mind, let’s assume you buy a brand new Nissan 370Z for $30,000. Let’s assume after adding taxes, license and insurance, the car’s cost increases to $33,000. If you used an auto loan to cover the entire amount, and then got in an accident five minutes after driving your brand new 370z off the dealer’s lot, this is how your insurance company would settle up with you:

Market value of your car: $27,300 (assuming 9% depreciation)
Less deductible: $ 1,000
Insurance proceeds to you: $26,300

Outstanding loan amount: $33,000
Less insurance proceeds: $26,300
Amount you owe the lender: $6,700 (!)

I don’t know about you, but if I was stuck having to write a check to my lender for $6700 after my car was totaled through no fault of my own, I wouldn’t be a happy camper. The good news is GAP insurance would cover that amount.

Reasons for Buying and Avoiding GAP Insurance

There are other reasons to consider buying GAP insurance. For instance, if you:

  • Finance your car for more than 4 years
  • Lease your vehicle
  • Purchase a new car with a history of high depreciation rates; especially budget-friendly subcompacts
  • Put less than 20% down
  • Drive more than 15,000 miles annually
  • Borrow more than the purchase price (usually to cover tax, license, insurance, and other extras)

On the other hand, you probably don’t need GAP insurance if:

  • Your car’s market value far exceeds the value of the loan
  • Your loan is less than 24 months

When I bought my new Honda Accord several years ago, I purchased GAP insurance from my auto insurance provider; the rate was $27 every six months and the price came out to 10% of the collision and comprehensive insurance premium. However, depending on the insurance company, that figure can be as low as 5%.

The Bottom Line

For what it’s worth, I didn’t renew my GAP insurance after the market value of my Accord exceeded the amount I owed on the vehicle. In total, I spent less than $100 for the peace of mind that came with my GAP coverage while I was “upside down” on my car loan.

Yes, in many cases guaranteed asset protection is the insurance industry equivalent to a belt and suspenders — but there are also plenty of scenarios that can leave you financially vulnerable without it. Keep that in mind the next time you buy a car — especially if you’re the type of person who is allergic to risk.

Photo Credit: StewC

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