GAP Insurance: Where to Get This Type of Auto Coverage
It’s common knowledge that new cars drop in value, virtually as soon as you drive them off the dealer’s lot.
In fact, a brand-new vehicle typically loses 20% of its value within the first 12 months of ownership.
But what happens if you purchase the vehicle with 100% financing, or even 90%, and the car is totaled in an accident?
Not to worry, that’s where a car insurance provision known as GAP insurance enters the picture.
If you have it in place on your new vehicle, your car loan will be fully paid, regardless of how much the insurance company will reimburse you for the loss of your vehicle.
What is GAP Insurance?
GAP insurance an optional car insurance coverage that will pay off an auto loan if your vehicle is totaled or stolen and the standard insurance payout (based on the depreciated value of your vehicle) still leaves you with a remaining loan balance.
Under a standard auto insurance policy, you’ll typically have collision and comprehensive coverage included in the policy.
- Collision will pay for damage to your vehicle that’s caused when you’re involved in an accident that’s determined to be your fault.
- Comprehensive will pay if your vehicle is damaged or completely destroyed while it’s parked.
The problem:
Collision and comprehensive will only pay what’s determined to be the vehicle’s value – which we’ll cover in the next two sections.
But the important takeaway is that value is likely to be less than the amount you owe on your vehicle if it was purchased with little or no money down.
What is “Actual Cash Value”?
In most cases, the insurance company will cover the cost to repair your vehicle to its actual cash value (ACV).
Actual cash value is the value your insurance company determines your vehicle to be worth at the time of the accident.
If the car is totaled in an accident, or if it’s been stolen, the ACV is the maximum the insurance company will pay on your claim.
In many instances, particularly with new vehicles, the ACV will be lower than the outstanding loan balance on the vehicle.
This is the exact reason why you need GAP insurance.
It will pay the loan off regardless of the vehicle’s value.
What is "Agreed Value Coverage"?
Agreed value coverage, or simply AVC, is a value where you and your insurance company agree on a specific value to the car at the time you buy the policy.
Using this method of coverage, the insurance company will include any options that make the vehicle more valuable than similar cars.
If your car is damaged, you’ll be reimbursed for the lower of either the cost to repair the vehicle or its agreed value.
Notably:
Depreciation is not calculated into the mix.
In theory at least, AVC can eliminate the need for GAP coverage. However, the insurance company will likely reassess the value of the vehicle at the beginning of each policy term renewal.
AVC is usually available for specialty vehicles, like classic cars, where GAP insurance is not offered.
It’s not available with all insurance companies and tends to carry a higher premium when it is.
How Does GAP Insurance Work?
GAP insurance will pay the difference between your car’s agreed value coverage and the outstanding loan balance or lease payout (but be aware that some insurance companies have different GAP provisions for leases).
This will only take place when the vehicle is sufficiently damaged that it’s considered to be “totaled” by the insurance company.
This typically is the result if the cost to repair the vehicle exceeds 60% or 70% of its agreed value.
Absent a GAP provision, you would need to pay the difference between your vehicle’s value and the loan or lease balance on it.
But with the GAP provision, the financing will be fully paid.
When is GAP Insurance Required?
You can assume GAP insurance will be required anytime you lease a vehicle.
But, it’s also a common requirement when you finance the purchase of a vehicle.
In a loan situation, you can expect GAP insurance to be required anytime your loan amount exceeds 80% of the value of your vehicle, or if the loan term extends more than 60 months.
And again, it may be required if the financing is for a vehicle that has a higher than normal rate of depreciation.
Where to Get GAP Insurance
You’ll typically get GAP insurance coverage from either:
- your insurance company, or
- the dealership where you purchase your vehicle.
When you purchase the coverage through your regular auto insurance policy, it’s typically less expensive.
In addition, you can drop the coverage when it’s no longer necessary.
Dealership GAP insurance
However, if you purchase it through the car dealership, you’ll typically be charged a flat amount for the coverage, which will then be added to your loan amount.
Since car dealerships typically earn a profit on the sale of GAP insurance, it’s almost certain you’ll pay more for the coverage provided by the dealer than you will through your own insurance company.
The other issue with dealer-provided GAP insurance is that it will be added to the loan and financed.
That means:
You’ll pay interest on the policy provision over the life of the loan. That will make the cost of the coverage even higher.
You should also know that purchasing GAP insurance through a dealership will make it much more difficult to cancel.
If a dealership offers you GAP insurance – and they may simply add it without consulting you – you should first see if it’s available through your regular car insurance provider.
Since it almost certainly will be, you should choose that option instead of buying through the dealer.
GAP insurance as a stand-alone coverage
The very best time to purchase GAP insurance is when you first buy or lease your vehicle.
That will ensure you’re covered from the very beginning.
This is also important because the gap between the actual cash value and the loan amount or lease value is never higher than at the very beginning of the term.
If you somehow avoid purchasing the coverage at the time you buy or lease the vehicle and your vehicle is totaled, you may need to pay thousands out-of-pocket to cover the remaining balance on the loan or lease.
However, it is possible to get GAP insurance as stand-alone coverage. This is typically done through online providers.
An example is a company called GAP Direct, which as the name implies, provides exclusively GAP insurance. They advertise policies starting at $185, which works out to be a little over $15 per month. They allow you to purchase coverage at any time as long as it’s before a loss occurs.
How Much Does GAP Insurance Cost?
Fortunately, GAP insurance is surprisingly cheap.
In fact, it normally adds only about $20 per year to the cost of a policy that includes collision and comprehensive coverage.
That’s an incredibly small price to pay for the benefit GAP insurance provides.
When GAP Insurance Makes Sense
If you’re either leasing your vehicle, or purchasing it with little or no money down, the lender will require you to have GAP insurance.
This is how they protect the value of your vehicle, which serves as security for either the loan or the lease.
But there are some circumstances where you may want to have GAP insurance, even if it’s not required by a financing company.
When you make a smaller down payment
GAP insurance makes sense any time you’re making a down payment of less than 20%, or financing the vehicle for five years or more.
This can be an important consideration since car loans now extend to as many as six or seven years.
Vehicles that depreciate quickly
You may also want to consider adding GAP insurance if your vehicle is one that depreciates faster than most other cars.
Trade-ins
But still another situation where it’ll be desirable – and is almost always required by the lender or dealer – is when you buy a new car, and trade in your old vehicle, which has a higher loan amount than the vehicle is worth.
This is known as being “upside down” on a car.
For example, let’s say you’re purchasing a brand-new car for $30,000. In the process, you trade in your current vehicle that’s determined to be worth $5,000 – but has a $7,000 loan against it. The dealer will give you a $32,000 loan on the new vehicle, which will incorporate both the cost of the new car and the loan deficiency on your old car.
In this scenario, you’ll automatically be upside down on the new vehicle purchase -- that will require GAP insurance.
How to Cancel GAP Insurance
If GAP insurance has been furnished by your dealer on purchase, the coverage will automatically cancel at the end of the loan term.
If you’ve purchased it through your auto insurance provider, you may need to contact them when you believe the coverage is no longer necessary.
The critical period
You may want to consider canceling the coverage after what’s known as the “critical period” passes.
That’s usually the first two or three years you own your vehicle.
At that point, the loan amount will likely be paid down sufficiently that a claim based on ACV will be enough to pay off the balance.
However, you may want to retain the coverage a little bit longer if your car loan extends to six or seven years, or if your vehicle is one that depreciates more quickly than the average car does.
Getting GAP Insurance Refunds
If you’re purchasing GAP insurance through your car insurance company, you can simply terminate the coverage any time you feel it’s no longer necessary.
The situation is more complicated with dealer-provided policies, due to the fact that the premium is included in your vehicle's financing.
The most common reasons for requesting a refund:
- paying off the loan early or
- selling the vehicle before the loan term expires.
If you do, you’ll need to request the cancellation and refund in writing. Exact handling of the refund process will depend on the GAP insurance carrier’s policies.
You may also want to cancel the coverage if you determine the loan amount has fallen beneath the ACV of the car.
You can determine the ACV by checking recognized online sources, such as Kelley Blue Book or Edmonds. Even so, you should make sure the loan balance is at least $1,000 or $2,000 below the ACV before attempting to cancel your coverage.
Bottom Line
GAP insurance is a very useful and inexpensive car insurance option.
It should be considered any time you’re either leasing a vehicle or taking a loan for more than 80% of the ACV of the vehicle, or with a term of more than five years.
