What Is the Biggest Issue With Gap Insurance?

When you buy a vehicle, it immediately depreciates in value. The problem with that depreciation is that if you total it before you pay down the loan, you could find that the check you get from the insurance company doesn’t cover the full amount you owe on the lender. Gap insurance is designed to protect you against that, but it doesn’t always cover the full amount due.

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Gap insurance covers the difference between a totaled car’s value at the time of the accident and the amount remaining on the loan. The biggest issue is that the payout doesn’t always completely close that gap.

Gap Insurance Payout Issue

If, as part of your portfolio, gap insurance is something you feel you need to purchase, it’s important to carefully scrutinize whatever policy you’re signing. Most gap insurance policies only cover factory-installed parts. This means if you’re the type of person who likes to “pimp your ride,” those upgrades won’t be covered.

You should also check the other things that were wrapped into your loan. If you purchased an extended warranty or credit life insurance policy, for instance, those amounts will be deducted from the check you receive. Gap insurance is merely designed to cover the depreciation in value compared to the purchase price on the day you bought it.

How Does Gap Insurance Work?

Gap is an acronym for Guaranteed Auto Protection. You’ll likely first hear about it when you’re seeking financing through the car dealership for your vehicle, but if you don’t, you can price car gap insurance on your own. You may also be offered gap insurance while signing up for a lease.

If you have an accident, your regular auto insurance will pay to repair the damage. If your vehicle is totaled, you’ll get a reimbursement for the car’s value at the time. If the amount your insurer issues doesn’t cover the full amount you owe on the loan, gap insurance will kick in to pay the difference.

Do You Need Gap Insurance?

Before you purchase, you may want to crunch some numbers to see if the premiums you’ll pay are worth it. If you’re buying a new car or you got a great deal on a used car, those numbers may not add up. If you have enough money in the bank to cover the difference if you total your car and your insurance check doesn’t cover it, you may find that you wouldn’t need the gap insurance payout and therefore can save the money you would have spent on premiums.

To get started, you’ll need to know the amount you’re expected to pay for the car, not including the fees and taxes that will be added to it later. Then you’ll need to calculate depreciation.

It can vary from one model to another, but you can plan on losing 10 percent at the outset, then 20 percent after the first year. After that, figure it will depreciate 10 percent each year. Look at the numbers and determine at what point your loan will be paid down enough to allow you to cancel your gap insurance.

Canceling Gap Insurance

Gap insurance is usually recommended for those who have less than a 20 percent down payment on a car purchase they’re financing. The gap insurance payout won’t be worth it if you’ve put 20 percent or more down. But it’s important to also monitor the balance on your loan and cancel it once you owe less than your vehicle is worth.

You’ll usually need to cancel your gap policy within one to two years of buying your car. To cancel, you’ll just contact the insurer and ask to cancel your policy. You should receive a refund in the mail for any amount you’ve prepaid.

How Much Is Gap Insurance?

The cost of car gap insurance will depend heavily on where you get it. If you purchase it through the dealership, you’ll find it’s much more expensive than if you went with a private insurer, but you may choose to do so for convenience purposes. A car dealership may also require you to make an upfront payment on the policy, which will be charged as a flat rate rather than as monthly premiums. You may also be offered gap insurance through the credit union financing your auto loan.

If you go through an auto insurer, though, premiums will be fairly minimal. You’ll probably only see a few extra dollars a month added to your policy. The fact that it’s so small, though, can make it easy to put off canceling it long after you no longer need it. Still, even if your premiums are only $5 a month, that’s $60 a year you’re paying unnecessarily if you keep it after you owe less than the vehicle is worth.

Gap Insurance and Leases

If you’re leasing a vehicle, you’ll likely see something called lease/loan insurance, which falls under the same general portfolio as gap insurance. Lease/loan insurance is similar to gap insurance in that it covers that “gap” in the event of a costly car accident. Lease/loan insurance pays the difference between what the insurer pays and what you still owe on your lease.

However, it’s important to note that unlike gap insurance, lease/loan insurance has a limit on how much it will pay. Generally, this amount is 25 percent of the vehicle’s cash value. It also won’t pay for any fees you paid when you leased the car, so you’ll still lose money on the deal.

Limitations on Vehicle Use

Before you purchase car gap insurance, make sure you look into any limitations on your use of that vehicle. If you are one of those drivers who puts quite a few miles on your vehicle each year, it depreciates faster than average. Gap insurance isn’t designed to cover that loss in value, so you may find your check is less than you’d hoped.

Other things that can accelerate the depreciation of a vehicle may also get in the way of full funding for the gap. If you use your vehicle for towing or if there’s prior damage to it, you may find you don’t get the payout you expected. You should also avoid paying gap insurance on a vehicle you’re storing instead of driving since prolonged storage can affect your payout.

Getting a Gap Insurance Refund

There is good news for your portfolio if gap insurance was something you purchased when you bought your car. If you sell or trade in your car early, you may be entitled to a refund for premiums you paid that weren’t used.

This money won’t be issued to you automatically, though. You’ll need to get in touch with your insurer and let them know the car is no longer in your name. At that point, you’ll likely be asked to submit proof of the payoff.

The reason for the refund is that when you financed your car, your gap insurance premiums were based on the purchase price of the vehicle, as well as the term of the loan. Since you’re reducing that loan term by selling your car, that means you won’t get the coverage that was promised to you when you signed the policy. In that case, the company may be required to issue some of those premiums in the form of a refund.

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About the Author

Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.


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