Click here to type your ZIP into our FREE search box to get FREE quotes for car insurance!
Not everyone needs GAP insurance, but in the right circumstances, it can be a very wise use of your money. Before buying or leasing a car, do the calculations to see if you’ll need GAP insurance.
GAP insurance is a special kind of car insurance that pays the difference between what you owe on a car and what the car is worth. Usually, the only time GAP insurance is needed if you lease a new car or are purchasing a brand new car with no or a small down payment.
New cars depreciate very quickly. They lose the most in the first year of ownership. Some will lose as much as 30% of their value within three months of purchase. If you buy a new car without a down payment or with only a very small one, your car will be worth less than your car loan for quite some time.
However, if you’ve paid a down payment, let’s say $6,000 on a $30,000 car, or 20%, then your down payment will cover most or all of the instant depreciation the new car will experience once it is driven off the lot. This means there will be little to no GAP, so no need for GAP insurance.
Leases require a very small down payment, and sometimes none at all. This makes leasing an attractive option for many people, but it does cause an issue with insurance. Because leasers are responsible for replacing the car if it is totaled in a wreck, they are in the same boat as someone who buys a car with no down payment. The car will be worth less than they have agreed to pay for it, often for the entire length of the lease.
Because used cars have already experienced most of their depreciation when the original owners bought them, people who buy used cars almost never need GAP insurance.
How GAP Insurance Works
Let’s look at how the math works. This rapid depreciation means that a $30,000 vehicle might only be worth $23,000 just three months later. However, if you’ve paid nothing down on the car, you’ll only have paid three car payments during that time. If your interest rate was 5% for five years, then after three payments, you’ll still owe about $28,600.
This is what’s called being upside down on the car. As long as you keep the car and keep making payments, this shouldn’t be a problem. Eventually you’ll pay the balance down enough so that the value is higher than balance you owe on the loan. The problem comes if you are in a wreck before that time.
If you are in a wreck, no matter whose fault it is, and the car is totaled while you are still upside down on the car, then you have an issue.
If you have a wreck three months after buying the car, then the insurance company will only pay you $23,000 because that is what the car was worth at the time of the wreck. That would leave over $5,000 you would still owe on the original loan. GAP insurance pays that difference, usually minus your deductible.
However, if the same person had put $6,000 down when he bought the car, by the time the wreck occurred, he would have brought the balance down to $21,700, well below the value of the car. Thus, he would have had no need of GAP insurance.
For more information on how GAP insurance works, read this article by Washington State Insurance Commissioner’s about it .
Getting GAP Insurance
Not all insurance companies sell GAP insurance. Laws about GAP insurance vary from state to state, so not all companies offer it, or only offer it in certain areas. Some state departments of insurance websites have a listing of companies who are authorized to offer GAP insurance in their states. If you think you need GAP insurance but are having a hard time finding it, check there or with your lender. Some lenders even offer it.
If you are leasing a car, you will almost certainly be offered GAP insurance.
Some states even require it. This is because you as the leaser are responsible for the full retail price of the car. However, leases usually have very low down payments and monthly payments. So you’ll usually be upside down during most of a lease.
If you fulfill the lease, that’s not an issue. You return the car and that’s the end of it. However if you wreck it, it’s very likely that the value of the car will be less than the original price minus all your lease payments. GAP insurance will pay the remainder to the leasing agency. Edmunds.com explains how GAP insurance affects a lease in this article.
Buying Versus Leasing
Most financial experts frown upon car leasing as a waste of money. While for most people, it isn’t a smart move, there are groups of people who can benefit from leasing rather than buying.
Leasing is best for those people who replace their vehicles every two to three years. Because lease agreements usually only last that long, someone who leases will have put far less money into the car for that period of time than someone who buys.
When you lease a car, you usually pay a lot less in down payments. The taxes are usually spread out over the term of the lease rather than paid up front like in a purchase.
Even the GAP insurance premium is often spread out over the monthly payments. A lease also sets the value at the end of the lease ahead of time. No need to worry about trade-in value or haggling when you’re ready to get a new car.
However, there are many downsides to leasing. Perhaps the biggest drawback is the lack of flexibility with the contract. When you lease a car, there are substantial penalties charged if you terminate the lease early. So if you lose your job and need to cut expenses, you can’t just turn in the car without paying several hundreds or even thousands of dollars in fees. If you’d bought one, you can sell it at any time.
A lease agreement also assumes a certain number of miles will be put on the car during that time, usually 15,000 miles per year. If you go over that amount, the leasing company will charge you a fee per mile over that amount. Go just 1,000 miles over the agreed limit, and you could easily pay an extra $200.
If you’re unsure whether buying or leasing is best, SmartMoney has a calculator to help you decide.
Cancelling GAP Insurance
Since you can’t transfer GAP insurance to another vehicle, and you can’t transfer it to a new owner if you sell the car, at some point you’re going to need to cancel it. You can cancel GAP insurance as soon as your loan balance is less than the value of the car.
You can determine this by checking sites like Kelley Blue Book for the value of your exact make and model. You can call your bank and ask for the loan balance. You can also get an amortization schedule that will give you a monthly balance.
If you sell or trade in the car, you can also cancel the GAP insurance as soon as the car is no longer legally yours. If you are leasing, you might have to carry it the entire term of the lease. Check with your leasing company to see for sure.
Other GAP Insurance Issues
One important thing to remember about GAP insurance is that it is a secondary insurance. GAP insurance only pays if the primary insurance pays first.
In other words, if you wreck your six month-old car, your collision insurance must pay out first. Then your GAP insurance will pay the GAP between what you owe and what the collision policy on your regular car insurance pays.
If you cancel your comp and collision insurance or allow your insurance policy to lapse, your GAP insurance is completely voided.
Not only would canceling this insurance violate your lending agreement, but also it could be financially devastating. If you allow your insurance to lapse and then cause an accident, you could be left paying the rest of your car payments with nothing but a totaled vehicle to show for it.
Finally, sometimes you can get a refund on your GAP insurance premiums if you never used it, but most of the time you won’t. It all depends on the type and terms of your particular policy. The most common scenario for a refund is when a dealership sells you the policy for a certain length of time.
If you buy a GAP policy, which will cover you for two years, after which the balance on your loan should be less than the value of the car, but pay the car loan off after only one year, you might be entitled to a refund for the premiums on the second year. This depends on the terms of the policy, so read yours carefully.
If you have any insurance related questions, the National Association of Insurance Commissioners has set up a website called “Insure U”. This website is designed to educate the public about all insurance issues.
We can get you fast and FREE quotes from several car insurance companies – just enter your ZIP into the box found here!