Gap insurance is an optional add-on coverage you can purchase when financing a new or used car. It helps pay the difference between what your vehicle insurance pays if your car is totaled and what you still owe on your auto loan. But is gap insurance really necessary or just a scam by car dealers to make more profit?
Gap insurance can provide valuable financial protection in certain situations, but there are also cases where it may not be worth the extra cost. Let’s take an in-depth look at how gap coverage works, its pros and cons, and whether you really need it or if it is just a waste of money.
What is Gap Insurance?
Also known as guaranteed auto protection or GAP coverage, gap insurance helps cover the “gap” between your car’s depreciated value and the remaining loan balance if your vehicle is totaled or stolen.
For example, say you owe $15,000 on your car loan but your vehicle is only worth $10,000 when it gets totaled in an accident. Your regular auto insurance will only pay you the $10,000 actual cash value of your car. Gap coverage pays the difference, which is $5,000 in this case.
Gap insurance may also pay your deductible, up to around $1,000 typically. It protects you from still owing money on a vehicle you no longer have after an insurance claim.
How Does Gap Coverage Work?
You purchase a gap policy when you buy your new or used car, either from the dealer or auto lender. Third party insurers also offer standalone gap policies.
If your vehicle is totaled or stolen within the policy term, gap insurance kicks in to cover the balance owed above the car’s depreciated value, less your insurance deductible.
The gap insurer pays the remaining loan balance directly to the lender. You avoid being stuck owing more than your car was worth at the time of loss.
Gap insurance only applies if your vehicle is declared a total loss by your regular auto insurance company. Minor damage claims would not trigger gap.
Gap Insurance Pros
Peace of mind – Gap coverage provides security knowing you won’t be on the hook for thousands of dollars if your car is totaled or stolen. This extra financial cushion gives peace of mind.
Loan balance protection – Without gap insurance, you could potentially have to continue making loan payments on a vehicle you no longer have if it gets totaled. Gap helps avoid this burden.
Deductible covered – Most gap policies include reimbursement for your auto insurance deductible up to $1,000. This saves you money upfront on your claim.
Lease protection – On a leased vehicle, gap insurance can cover the difference between insurance payout and early lease termination fees.
New car protection – Depreciation hits hardest in the first couple years. Gap coverage protects against owing more than the rapidly declining value.
Gap Insurance Cons
Added cost – Gap insurance premiums add a few hundred dollars upfront to the cost of your vehicle purchase.
Limited coverage – Gap only covers the loan balance difference and deductible. It does not pay for medical bills or other accident-related costs.
Loan term restrictions – Gap policies typically expire after 3-5 years. Longer loan terms may not be fully covered.
Exclusions – Gap insurance may not cover loan defaults, missed payments, warranty costs, overdue charges, etc. that can contribute to being underwater. Read exclusions closely.
May already have coverage – Some new car warranties come with free gap coverage. Your auto insurance may include loan/lease payoff coverage.
Incentivizes underwater loans – Knowing gap will cover potential upside-down loans could lead some buyers to accept loans greater than the car’s value.
Do You Really Need Gap Insurance?
Whether gap coverage makes sense depends greatly on your specific auto loan situation and level of risk:
Upside down loan – If you owe more than the car is worth from day one due to low down payment, gap insurance can pay off the difference and provide security.
Longer loan term – Loans of 5-7 years have more time for vehicles to depreciate below the balance owed, making gap useful.
Lower down payment – Smaller down payments contribute to being underwater on the loan, increasing gap risk.
New car – Depreciation is steepest in the first 1-3 years. Gap gives peace of mind with a brand new vehicle.
High mileage driving – Heavy mileage driven will accelerate depreciation and increases total loss risk. Gap is a good hedge.
Poor condition vehicle – If your car has existing damage or is prone to breakdowns, gap offers protection if it gets totaled.
Lease – Since leased vehicles have lower insurance value versus early termination costs, gap is very useful.
Safe driving record – Those less likely to get in accidents may determine gap insurance is an unnecessary cost.
Is Gap Insurance Worth the Cost?
The value of gap coverage boils down to your personal tolerance for financial risk and how likely you are to need it. For many car buyers gap insurance provides significant peace of mind that is worth the expense. Here are key factors to consider:
How long do you plan to keep the vehicle? Shorter terms reduce risk of depreciation below loan value.
What is the vehicle’s predicted depreciation curve? Faster depreciating cars have greater gap risk.
Are you putting significant money down? Higher down payments make being upside-down less likely.
Did you get the best possible interest rate from the lender? Better rates mean less interest paid.
Do you already have any gap-like coverage from other policies? No need to duplicate.
How financially stable are you? Could you afford loan payments on a totaled car if required?
For most new car buyers and those with loans exceeding 60 months, the relatively low cost of gap insurance provides valuable peace of mind in case of total loss. But for used cars and shorter 3-4 year loans, the benefits may not justify the extra expense.
Are Car Dealers Pushing Gap Insurance as a Scam?
Since gap insurance is a significant source of profit for dealers, they have a strong incentive to aggressively push it on customers, even those who may not really need it. Some buyers report feeling forced into purchasing gap insurance in order to have their auto financing approved.
According to consumer advocacy groups, common high-pressure gap insurance sales tactics from dealers include:
Refusing to finance vehicle purchases without gap coverage
Misrepresenting that gap insurance is required by law or by lenders
Burying gap in loan paperwork without properly informing consumers
Quoting monthly loan payments with gap cost included but not disclosed
Adding on gap insurance without customer consent
Lying that gap insurance cancels when the loan balance drops below car value
Overstating the financial disaster scenarios if gap coverage is declined
Reputable dealers allow customers to evaluate the pros and cons of gap insurance and make their own decision. Unfortunately, gap add-ons have also become a gray area ripe for abuse by predatory car dealers seeking to inflate sales numbers and dealership profits.
Is Gap Insurance Required When Financing a Car?
Gap insurance is never legally required to purchase a vehicle or obtain auto financing. Lenders may recommend gap coverage because it lowers their risk, but they cannot force you to buy it. Beware of any dealer that claims gap insurance is mandatory or required by law. This is a deceptive sales tactic.
However, the dealership may make gap coverage a condition of offering you certain interest rates or loan terms, which they have discretion to set. You always have the right to refuse gap insurance, but it may impact loan approval if it violates company financing policies.
Getting Value From Gap Insurance
Gap coverage makes the most sense for certain buyers – new cars, long loans, low down payments, and high depreciation vehicles. But it may provide little benefit to others. Follow these tips for getting your money’s worth on gap insurance:
Shop multiple gap quotes and compare costs
Verify policy covers the entire length of your loan
Review what is excluded – defaulted payments, warranties, etc.
Bundle gap with tire/wheel protection for added savings
See if you already have gap-like protection from other policies
Cancel gap coverage once you have 20%+ equity in your vehicle
Understand your legal rights regarding add-on products at dealerships
With a little bit of education, you can make an informed decision about gap insurance. While dealers aggressively push it for their own gain, gap coverage does provide legitimate protection against financial loss in many car purchase situations. Evaluate your personal loan circumstances to determine if the peace of mind is worth the cost.
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