You’re the first car in line at a red traffic signal. The light changes to green and you instinctively start forward. Halfway through the intersection you’re T-boned by a driver who ran their red light.
Turns out they have no insurance and your car is declared a total loss by your insurance company. Blue Book value on your car is $20,000 and you owe the finance company $30,000 on your car loan. This means you’ll have to come up with $10,000, even after the insurance company cuts a check — unless you have a specific type of insurance coverage.
That’s how GAP insurance can save you.
What Is GAP insurance?
Guaranteed Asset Protection insurance, or GAP insurance, covers the difference between what you owe on a car and its actual cash value (ACV).
Regardless of whether you buy or lease a car, depreciation begins the moment you take possession of the car. In most cases, the value of a car drops by 20 percent during the first year of ownership. This is why most experts recommend making at least a 20 percent down payment when you finance the purchase of a new car.
As you may have surmised, ACV is a byproduct of the depreciation process. A large down payment can help offset the difference between the ACV and your loan amount. However, GAP insurance will protect you in situations in which it doesn’t.
When GAP Insurance Comes in Handy
According to the Insurance Information Institute, situations in which you’ll be well advised to have GAP insurance include when you’re:
• Making less than a 20 percent down payment
• Financing for 60 months or longer
• Leasing a vehicle (carrying gap insurance is generally required for a lease)
• Purchasing a vehicle that depreciates faster than the average
• Rolling negative equity from an old car into a new one
By the way, other than leasing a car, all of the above are unwise ideas in general, precisely because you can become mired in situations in which you owe more than a car is worth.
How to Get GAP Insurance
If you avail yourself of one of the best lease deals, you’ll find GAP insurance is usually already included in the deal. In other words, it’s mandatory. This is because the leasing company is intent on protecting the investment it has in the car.
On the other hand, it can be optional when you purchase a car, in which case you can include it as a rider on your basic car insurance policy. Some car dealers offer it as part of the purchase process, in which case the premium will be rolled into your monthly car payment. While this is convenient, it’s almost always more expensive than getting it on your own. There are also insurers who specialize in GAP coverage.
A Rose by Any Other Name…
A form of GAP coverage is sometimes referred to in insurance policies and purchase contracts as loan/lease payoff — or residual debt endorsement. While it can be reassuring to find you have this coverage, be apprised it might not cover your entire outstanding balance. In most cases, it’s only good for approximately 25 percent more than the settlement amount.
While that can often be enough, if your car experiences heavier than average depreciation, this could leave you still holding the bag. It’s a good idea to do some research to make sure you have enough coverage, or get a GAP policy on top of that one, just to be on the safe side. The good news is with one of those in place, the cost of GAP insurance will be less — which is yet another way GAP insurance can save you.