What To Know About GAP Insurance Before Buying Your Next Car

by Mark Albertson

Many new car buyers underestimate the safety net provided by GAP insurance. Here is what you should know to make your next auto purchase the best car-buying decision you ever made instead of the costliest.

It makes no difference whether you plan to lease your next car or buy it. You need to protect yourself against the catastrophic loss of your vehicle. A loss that could cost you thousands of your hard-earned dollars.

In the twelve years I was in car sales, many customers overlooked or underestimated one form of protection. That protection was GAP insurance. GAP means Guaranteed Auto Protection. And here is how it works.

How GAP Insurance Works

Let’s say that you buy a new car, and six months later, you have an accident. Your insurance company comes out and assesses the damage. The car is deemed a total write-off, and your insurance company writes a check for the car’s value. Since the first year of ownership is when the greatest amount of depreciation occurs, the check from your provider will be noticeably less than what you paid for the vehicle.

If you owed nothing on the vehicle, you have cash in hand now to purchase another. But if you owed more than what your old car was worth, your insurance check will not satisfy the overage from your loan.

And guess who is responsible for the shortfall?

You are. Depending on how much you owe, that shortfall could cost you thousands of dollars. Unless, of course, you were smart enough to buy GAP insurance.

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GAP Insurance in Action

Let us put together a scenario that shows GAP insurance in action.

Suppose you buy a car that costs $25,000. After tax, motor vehicle, incidentals and finance charges, the total comes to $32,000. You put down $5,000 and finance the car for five years. This means over the next sixty months, you owe the bank $27,000.

Six months later, you have an accident and your insurance company totals the car. They reimburse you for what the car was worth and write a check for $19,000. Now, during that period of six months, you made six payments on your loan, totaling $3,000. Subtract that from your starting balance of $27,000 and you still owe $24,000.

But the check the insurance company wrote is for a loss of $19,000. You now have to come up with $5,000 out of your pocket to finish off the loan. However, if you had GAP, you could keep your $5,000. The bank gets your insurance check for $19,000, and you get to breathe easy.

Does Every New Car Owner Need GAP Insurance?

No. If you pay cash for your car, you do not need GAP. Why? Because there is no loan outstanding against the vehicle. If you finance the car for three years or less, you probably will not need GAP. If you put down a large amount of money against the finance, say thirty percent, then the down would probably handle the depreciation and save you from being upside down in the event of loss.

But if you are putting little or no money down and are financing for four years or more, chances are that you will need GAP. If you have suspect credit and get approved for purchase with a high interest rate, you will need GAP. (See 7 Monthly Bills Affected by Your Credit Score.)

Whether or not you need GAP will depend on your calculations, so do your homework. There is no reason for you to spend more money than you have to when buying a car.

If you are going to lease your new car, GAP protection is imperative. Revisiting the above scenario of an accident six months down the road, the reimbursement check from your insurance company will most likely not cover your remaining lease payments, plus the buyout printed on your lease contract.

The good news is that a number of states require lending institutions to include GAP in their contracts. So check your state laws before venturing into your local dealer. The last thing you want is to have some smooth-talking finance manager coax you into paying for GAP when, by law, it is part of the deal.

Where Can You Get GAP Insurance?

Most dealers offer GAP. However, you will pay top dollar for it here.

Start with your insurance company. In fact, go over your current insurance policy. You might find GAP is included and not even know it! If not, ask your agent for a quote. Also, check other providers of GAP as well.

Rating services like A.M. Best and Standard and Poor’s can help here. Prices range from $50 to $100 per year. However, by doing your shopping, you might find it for less.

Once you have educated yourself on GAP pricing, you can not only negotiate the price of the car with your dealer, but also GAP protection as well. However, remember that if you get GAP from the dealer, it will be included in your loan, which means you will pay interest on it. Unless, of course, you pay for GAP in a lump sum.

Do not underestimate the safety net provided by GAP insurance. It could be the best car-buying decision you ever made.