A relatively new innovation in the world of auto insurance, GAP coverage allows car buyers to make certain that the entire balance owed to a finance company will be taken care of in the event of a totaled vehicle or theft. This could otherwise be difficult if the car is badly damaged or stolen soon after it is purchased.
If a vehicle is bought with a special financing package that involves little or no down payment, the car’s actual value may decrease faster than the loan balance. Guaranteed Auto Protection, usually abbreviated as GAP, offers vehicle owners the opportunity to have the loan paid off in its entirety without any out-of-pocket expense. These policies can be written at the time of purchase and are prepared by the financing representative at the dealership.
Why You Might Need GAP Coverage
If a buyer makes a purchase of a new or used car and pays little or no money down, the problem of an upside-down loan is an immediate concern. This is especially true if the loan agreement includes the cost of the vehicle tax, title, and licensing. For example, if a new car is purchased for $20,000 with no money down, the car may be worth only $17,000 when it is driven off the lot.
This $3,000 difference ($20,000 – $17,000 = $3,000) due to depreciation is the amount GAP covers. During the first year the car is owned by the consumer, interest accrual on the loan may equal or exceed the payments made. In other words, after 12 months the principal balance on the loan will not decrease significantly and can even increase slightly. During the first year of ownership of the vehicle, there is no equity being built.
If the car is totaled during this period, the insurance adjustor will take into consideration the depreciation on the vehicle. This could be as much as 15-20 percent. When the insurance deductible is figured in, the total amount paid by the insurance company to the lender may be only about $17,000, as illustrated in the example above.
This leaves a gap of $3,000 that the vehicle owner will have to pay directly to the lender, in addition to the payments they have already made. However, if GAP insurance has been purchased to cover this amount, the vehicle owner is off the hook and it fills in this gap, literally.
How Much Does GAP Coverage Cost?
This is the one drawback to purchasing this type of protection. The average cost of GAP coverage is approximately four percent of the car’s initial value. Consumers will have to decide whether paying upwards of $600 is worth it. However, this amount can be paid out month-to-month.
Drivers must take into consideration the likelihood of causing an accident that results in a total loss of the vehicle. This type of coverage does not apply to damage caused by another motorist. The required liability insurance carried by the other driver would be used to cover vehicle damage.
Rates for GAP coverage are not influenced much by the driving record of the vehicle owner, age, gender, or residence location of the policyholder. The rates are rather standard and vary only slightly from one provider to another. Vehicle owners can ask if the dealer works in partnership with more than one provider of this coverage.
A Debt Cancellation Agreement
In a sense, GAP coverage is not really insurance at all, but rather a guarantee that the debt owed to the finance company will be taken care of completely. It is a supplemental form of protection that is either never used or used only once. The agreement is often written for a period of only six months or one year, after which the payments are canceled along with the coverage.
Before taking out this form of protection, car buyers should make a checklist that includes such information as the price of the vehicle, the amount made as a down payment, the insurance rate on the auto loan, and the likely cash value of the vehicle over the next 12 months. Some cars depreciate more rapidly than others, and buyers should be aware of the probable market value of the car during the first year of ownership.
In conclusion, it should be noted that GAP coverage is no longer needed and should be discontinued once a car’s value exceeds the amount remaining on the loan.