Chances are if you’ve bought a vehicle at a car dealership in recent years, you were offered a financial product called GAP. If you’re like me, at first it sounded like a great product and you signed on the dotted line buying the GAP insurance product. But did you need it? As it turns out, you may not have needed it and perhaps you were even somewhat mislead by the auto dealership as to what it would cover.
The truth is that all GAP insurance products are not created equal. You don’t have to purchase the product at the dealership, and sometimes this is a good decision. They’re selling it to you at a cost, rolling it into your loan, and charging you interest on the few hundred dollars it may actually cost. In order to determine whether you need it or not, let’s talk about what it is and what GAP covers.
GAP specifically is an acronym for “guaranteed accident protection.” The simplest way to understand how it works is to explain it using a scenario. Imagine you just bought a brand new truck financing a total amount of $40,000 which included some dealer installed aftermarket accessories, sales tax, and other applicable state and local fees.
After making six months’ worth of payments you are involved in a very serious collision which results in a total loss of the vehicle. Your full coverage auto insurance plan will provide you with a payment representing the ACV (actual cash value) of the truck before the accident less the deductible. Since you bought the truck new, it has depreciated significantly and you only receive $32,000 from your insurance company. This leaves a balance of around $7,000 (maybe a little less) that you owe to the bank. This is where GAP comes in.
Your GAP policy will pay the remainder of the loan due to your bank so you’re not stuck with the extra. As I mentioned earlier, not all GAP products are created equal. Some will reimburse you for your deductible. Some will cover those dealer installed accessories such as the bull bar you financed as part of the purchase.
However, others will not cover aftermarket accessories regardless of whether you purchased them at the dealership and rolled them into the loan. If you’re going to purchase GAP from the dealership, be sure you know what it will cover and what it excludes.
Some GAP products will not even cover the negative equity on the vehicle you traded in which was rolled into the new loan. Yet, it’s a common misrepresentation by auto dealers who will try to tell you that the bank is requiring GAP protection since they’re rolling negative equity from a previous loan over to the new one. In many cases, the GAP won’t even cover that amount. So be sure you’re aware of the coverage you buy.
Generally speaking, GAP insurance is recommended in the following scenarios:
- You’re purchasing a new or used vehicle with little to no down payment.
- You’re financing the sales tax and licensing fees.
- You’re buying a used vehicle at or above the Kelly Blue Book value.
- You’re trading in a vehicle which has negative equity.
- You’re financing at a higher than average interest rate.
However, if none of the above apply, you may not need the extra protection. It is always recommended to avoid financing more than a vehicle is worth. So long as you do that, you’ll likely never need GAP insurance. I should also point out that you can cancel a GAP policy and receive a pro-rated refund for the balance. So it’s always a good idea to cancel it once your loan balance falls below the value of the vehicle.