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February 25, 2015

by Aaron Crowe

When is Gap Insurance a Worthwhile Purchase

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Unless you buy a Corvette or other classic car that’s likely to appreciate, you could find yourself owing more on your car loan than the vehicle is worth after an accident.

That’s because the average new car loses 11 percent of its value the moment you drive it off the dealer’s lot, according to During the first five years the car depreciates by 15-25 percent each year.

If your car is totaled, your car insurance company is only going to pay you the current value of the car before it was totaled, not the original purchase price. If you own the bank more than the value of the car, you still have to pay the loan.

Gap insurance could fill that hole, covering the difference between what you owe and what your vehicle is worth.

For example, if you owe $20,000 on your car loan and the vehicle only has a Kelley Blue Book value of $15,000, your regular auto insurance will only cover up to the $15,00 and Gap insurance would pay the remaining $5,000 so you don’t have to pay anything over the $15,000 the car is valued at, says Ashley Harris, vice president of corporate communications at Generations Federal Credit Union in San Antonio, Texas, which sells Gap insurance.

A real-life example

It can also be needed when rolling over negative equity from a prior auto loan to a new auto loan, or purchasing a car for more than MSRP, says Harris, who knows first-hand the importance of gap insurance when she was upside down on a car loan after trading in her vehicle for a new one.

Two years ago she bought a 2013 Lexus and rolled approximately $5,000 in negative equity from her previous auto into the new loan. After only having the Lexus for two months, she was in an accident and the car was totaled.

She owed about $37,000 and the car was only worth $32,000. But because she had Gap insurance, she didn’t have to come up with the $5,000 difference herself. Harris filed a claim and within two weeks “my auto was paid in full and I was able to get a new auto without any problems,” she says.

Harris has a friend who didn’t have Gap insurance when his girlfriend was driving his vehicle and was involved in an accident. The vehicle was totaled and was valued at $17,000 by his insurer, though he owed $23,000 on the car loan. His insurer paid him the $17,000 value of the car, and he paid was left to pay the $6,000 difference on his car loan, she says.

“When he finally decided to go and get a new vehicle he was then hit with the reality that he was going to have two auto payments until his totaled auto was paid off in full,” Harris says.

It can also cause problems with a debt-to-income ratio because a remaining balance on the totaled vehicle will be shown until the debt is paid off in full, she says.

Costs of Gap insurance

A car dealership is usually the first place where car buyers learn about Gap insurance, especially if they’re financing their purchase through the dealer. But they don’t have to buy it from the dealer, and they don’t have to buy it immediately, says Paul Nadjarian founder and CEO of Mojo Motors, which tracks used cars at dealerships.

“The dealers do a good job making you feel you need it when you get a car,” Nadjarian says.

Dealers often charge more than your insurance company or credit union will for the same Gap insurance policy.

“All Gap policies are the same no matter what the dealer tells you,” Harris says. “The only difference in this instance is the dealership will mark up the purchase price far more than your local credit union will.”

A dealership will usually sell Gap insurance for $700 to $1,000 for the life of the loan, versus $200 to $400 at a credit union, Harris says.

To collect on a Gap policy, you’ll need to show the Gap insurer documentation from an auto insurer for your totaled car that includes the amount they’re paying, says Thomas Simeone, a lawyer in Washington, D.C., who helps clients collect on such policies. That payment will go directly to the loan company, Simeone says.

“It is important that you keep making monthly payments on your car after an accident and until the note is fully paid off,” he says. “In other words, the loan is still an obligation, even if the car is wrecked.”

The Gap insurer will want documentation from the lien holder that the insurance proceeds are less than the amount owed, he says, and then it will pay the lien holder the balance. “You will not see any money, but the loan will be paid in full,” Simeone says.

Other ways to cover yourself

If you guy Gap insurance from a car dealer, the cost can be rolled into the loan and you won’t see much of an increase in the monthly payment.

Or you could pay for a year of Gap insurance at one time, which may be difficult to do, or your insurer may allow you to make monthly payments if you buy it through them.

Gap insurance often isn’t needed after three years once enough equity is accumulated. That can be a good time to check on the value of your car and see if you no longer need Gap insurance, Nadjarian says.

“Sometimes you forget to take it off your auto insurance,” he says.

Instead of buying Gap insurance, one option is to take that savings and put it aside in case your car is totaled and you owe more than the car is worth, says Dan Young, senior vice president at Carstar, an auto body repair business.

The average age of a car on the road today is 11.5 years, Young says, so many owners probably don’t need Gap insurance. But if they do, they should consider how they’d pay for that gap if their car is totaled.

“How much of this risk can I absorb myself if something happens to my car?” Young asks.

Another option, if you can afford it, is to put a large enough down payment down when buying a car so that the loan is reduced to the Blue Book value or below, and you won’t need Gap insurance, Simeone says.

When to get Gap insurance

Most people aren’t disciplined enough to put money aside for such a payment, Young says, and Gap insurance would work for them when it’s needed the most — in the three years after a new car is bought.

Another time when it makes sense to buy Gap insurance is if you have bad credit and have a high interest rate on your car loan, Nadjarian says.

If you’re financing a car with a minimal down payment or you have little to no equity after financing the car, Gap insurance could save you thousands of dollars, says Todd Balderson, owner of Balderson Insurance Agency in Silver Spring, MD.

Some lease agreements also require Gap insurance, says Balderson, who recommends contacting your insurance agent when buying a new or used car for advice on recommended coverage for the car and to discuss options for Gap insurance.

Gap insurance is best for people who don’t have the down payment money and can’t pay the gap if their car is totaled, says Simeone, the lawyer.

“If you have the money, either put it down or, if you want to hold onto it at time of purchase, know that you will have to pay a gap if you have an accident,” he says. “Either option will save you the premiums and put you financially ahead in the long term.”

The good news is that if you do need Gap insurance, you’ll probably only need it for three years or so before you build up enough equity. It’s just a matter of deciding if you want to take the risk of not having it during that time, and hoping you don’t get into a major accident.

“It doesn’t happen that often,” Nadjarian says of having to use Gap insurance. “But when it does happen, it’s painful.”

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