Once you drive a new vehicle off the dealership lot, you can start bidding farewell to its value. That’s because the average new car loses 9-11% of its value when it’s sold. This depreciation trend continues over the first three years by as much as 60%.
If you took out a loan to buy your vehicle, the situation can get even worse. Depreciation can leave you with an upside-down car loan, meaning you owe more on the loan than what the car is worth.
Typically, an upside-down car loan is just a normal part of car financing (at least in the beginning of the loan). But it becomes an issue if you're in an accident that results in the vehicle being a total loss or a thief nabs the car and the police can’t recover it. In a total loss situation on an upside-down loan, your car insurance may only pay a portion of the loan, saddling you with debt for an undrivable vehicle.
GAP insurance steps in at this point to cover the gap between what you owe and the vehicle's value.
What Is GAP Insurance?
An acronym for Guaranteed Asset Protection, GAP insurance pays the difference between what you owe on your car loan and the amount of money — depreciated or actual cash value (ACV) — your insurance company gives you for your vehicle following an accident or vehicle theft.
To receive this payout, the insurance company must deem your vehicle a total loss, meaning the cost to repair the vehicle exceeds its value or the police never recovered it after a theft.
How GAP Insurance Works
Let's say you buy a new vehicle at $34,000 with interest, so you owe $40,000 total. One year into the loan, you still owe $35,000 on the vehicle, but the vehicle’s depreciated value is now $27,000.
Keep in mind, the depreciated value isn't necessarily the value you'd find online. Instead, this is a complex calculation your insurance company makes using a wide range of variables, including:
- Vehicle age
- Vehicle kilometres
- Past insurance claims made on the vehicle
- Vehicle wear and tear
- Comparable sales value in your area
If your vehicle is stolen or totaled in an accident at that one-year mark, your auto insurance company must pay for the damage. Instead of cutting you a check for the full loan amount, your insurance company will pay you the $27,000 depreciated value. That leaves an $8,000 gap between the loan balance and your car insurance coverage payout.
That extra $8,000 doesn't just disappear — you're on the hook to pay this extra amount. The bank that financed your loan will expect this comes out from your pocket.
GAP insurance coverage will cover this $8,000 difference so you don't have to pay it. Additionally, some GAP insurance covers your insurance deductible, giving you even more value for the monthly GAP insurance premium from your insurer.
When Should You Consider GAP Coverage?
According to CCC Information Services, nearly 18% of all vehicles involved in a car accident will end up as a total loss. If you fall into that 18% and are upside-down on your loan, GAP insurance will cover the remaining car loan balance after your insurance company's payout.
That said, you must evaluate your situation to determine if you're a strong candidate for GAP coverage. Here are some situations when it's a good idea to consider GAP coverage.
You Took Out a Long-Term Auto Loan
GAP coverage is a smart investment for those who take out a long auto loan term — generally 60 months or more — with little to no down payment. Because you're stretching the payments out over a longer period, which reduces the principal balance on the loan slower than a short-term loan, you'll owe more on the loan than the vehicle is worth for several years. This is known as negative equity.
You Rolled Negative Equity Into Your New Loan
It's not uncommon for car owners to grow tired of a vehicle after the first few years and decide to trade it in. Sometimes, this results in a negative equity trade, meaning you owe more on the trade-in vehicle than the dealership pays you for the trade.
When this happens, some lenders will allow you to roll that negative equity into an auto loan. This negative equity combined with the depreciation of your new car can result in an even larger gap between the vehicle's value and the loan balance, which you'd have to pay in the event of a total loss.
GAP coverage will pay off this negative equity, making it a great option for this situation.
You Drive a Lot
If you have a long daily commute or use your vehicle for business, then you likely load kilometres onto the odometer. These extra kilometres can drive the vehicle's value down even faster, creating an even larger gap between its value and the loan balance.
GAP insurance is perfect in this scenario, as it'll pay that large difference and get you out of the loan if the vehicle is a total loss.
You Have a High Interest Rate
Most car loans hover in the 4-5% interest range. However, if your credit is a little shaky or the loan terms are risky, lenders may charge higher rates. The problem with higher rates is that it means a larger portion of your payments in the first few years of your loan will pay interest instead of paying down the balance.
These interest-heavy payments can leave a large principal balance — the amount owed on the vehicle — for several years while the car still depreciates quickly. This is the perfect storm for a leftover balance in the event of a total loss. GAP insurance ensures that the leftover balance doesn't hit your wallet.
You Leased a Vehicle
GAP insurance is also a wise choice when leasing a vehicle. Despite not owning a leased vehicle, typical lease contracts require you to return the vehicle in good condition with no more damage than general wear and tear. So, if the leased vehicle is stolen or you get in an accident, you're responsible for the costs — that is, unless you have GAP insurance.
Fortunately, many lease agreements roll GAP coverage into your monthly payment so you don’t have to shell out a lump sum upfront. If your lease agreement doesn't roll it into your monthly amount, you can add it before you sign the final contract.
When Should You Skip GAP Insurance?
GAP insurance can be extremely helpful, but not all buyers need it. Here's when you can skip GAP insurance altogether.
You Made a Sizable Down Payment
Generally speaking, you can skip GAP insurance if you make a down payment of 20% or more. When you make a sizable down payment, you likely have enough equity in the vehicle that the loan value and the market value of the car are nearly identical. In this case, the GAP insurance won't provide any additional funds because the amount you receive from your insurance company will cover the loan balance.
You Paid Cash for a Vehicle
If you paid cash for a vehicle and didn't take out a loan, there's no reason to buy GAP insurance, as there's no loan balance to cover.
Who Offers GAP Insurance?
If you decide that GAP insurance suits your needs, there are several ways to get it: from the dealership, your insurance company, or an independent GAP insurance company. We'll cover each way to secure GAP coverage and its pros and cons.
Buying GAP Insurance at the Dealership
As a part of closing the deal, car dealers will usually offer you several optional products, including GAP insurance. Dealerships will partner with a GAP insurance provider to sell their products directly to customers, so they leave the dealership covered.
Pros of buying GAP insurance at the dealership:
- You leave the dealership with coverage
- One-stop shopping
- Can roll the policy cost into your loan
- Price is sometimes negotiable
Cons of buying GAP insurance at the dealership
- Some dealers may charge you a inflated price for GAP
- Risk of dishonest salespeople selling you GAP coverage you don't need
While some of those cons may be alarming to read, bear in mind that Clutch does things differently than traditional dealerships. First, we proactively alert our customers when they aren't a good candidate for GAP insurance. For example, if someone put down a sizable down payment or paid cash and asked for GAP coverage, we would explain why they don't need it.
At Clutch, we also ensure that all our optional services, including GAP insurance, are fairly priced based on market trends.
Buying GAP Insurance From Your Auto Insurer
Your auto insurance policy may also offer optional GAP coverage for an additional fee. When calling your insurer to get a quote on adding a prospective new or pre-owned vehicle to your policy, you can also ask if they offer this.
In most cases, you can get a quote for auto insurance and GAP coverage online, but some companies may not offer this service.
Pros of buying GAP insurance from your auto insurer:
- May get package savings
- No middleman between you and your insurer
Cons of buying GAP insurance from your auto insurer:
- May not go into effect immediately
- No ability to negotiate
- Shopping competitors requires shopping for all-new insurance policies
- Cancellation policies may be confusing
Buying GAP Insurance From an Independent GAP Insurance Provider
The final option is to call around or search online to find an independent GAP insurance provider. These can range from small local businesses to massive corporations with thousands of customers. Typically independent GAP insurance providers offer their services through dealerships so you wouldn't be able to access their product unless you dealt with a dealership partner.
Some companies will allow you to get quotes and activate your GAP insurance policy online, but others may require a phone call or visit to their office.
Pros of buying GAP insurance from an independent provider:
- Buying direct may save you money
- Countless companies to choose from
- Might get an array of competing offers relatively quickly
Cons of buying GAP insurance from an independent provider:
- Each company has different terms and conditions you must also compare
- Time-consuming process
- Coverage may not be immediate
- Smaller companies can go out of business after you purchase the policy
What Red Flags Should You Look For?
As you’ve read, there are plenty of benefits to buying GAP insurance at a dealership. Generally, dealerships keep your best interests in mind when offering optional coverages like GAP insurance. However, there are still a few red flags to watch out for when purchasing GAP coverage at the dealership.
Overcharging for GAP Coverage
Overcharging for GAP is a big issue because few car buyers know how much this optional service should cost. As such, dealers can mark it up at their leisure and you'd be none the wiser.
GAP coverage pricing varies by the vehicle, but the normal premium you can expect to pay is $1,400-$2,400. Anything more than this, and you may be getting overcharged.
At Clutch, we always ensure our GAP insurance premiums are fair and on par with market rates.
Unnecessarily Selling You GAP Coverage
Whether you asked for GAP coverage or the dealership offered it to you, any reputable dealer will let you know when you're not a good candidate. Remember, if you paid cash or put at least 20% down on your vehicle, you likely don't need GAP coverage. If the dealer still tries to push it on you or lets you buy it without contention, this is a giant red flag.
At Clutch, we will never sell you any extra coverage you don't need, including GAP coverage. And if you request GAP but it doesn't make sense for your situation, we'll let you know.
Making GAP Coverage Sound Like a Requirement
In a high-pressure sales environment, the salespeople may use any tactic they can think of to dig deeper into your wallet. This also applies to GAP insurance, as some salespeople will make it seem like the lender requires GAP coverage.
This is not only dishonest, but it's also illegal. At Clutch, we pride ourselves on delivering a stress-free buying process, so you never have to worry about high-pressure sales tactics like this.
Let Clutch Protect Your Investment with GAP Coverage
When financing a vehicle, GAP insurance can be a big money saver. After all, no one wants to pay off a loan for a vehicle they can no longer drive. With GAP coverage, your loan balance is covered no matter how upside-down your loan is.
At Clutch, we approach GAP a little differently than traditional dealerships. We’ll evaluate your situation to determine if GAP coverage will benefit you. If it won’t, we’ll let you know you don’t need it, plain and simple. If it’s best for your situation, we offer quality coverage at a fair market price to ensure your pre-owned Clutch vehicle has the coverage you need to avoid unexpected expenses. This way, you’re protected and won’t go broke.
