What Everybody Ought to Know About GAP Coverage

"GAP stands for Guaranteed Asset Protection," says Sonia Steinway, CEO of Outside Financial. "It covers the difference between the value of your car and what you owe on your loan if your car is totaled or stolen. That 'gap' can be worth thousands of dollars because many people borrow more than the car is worth, even at the dealership, and cars depreciate as soon as they're driven off the lot."

GAP coverage can be in the form of a GAP waiver or GAP insurance. These differ in several ways, but for the most part, offer the same type of protection to car shoppers.

Read more: GAP Insurance vs. GAP Waiver: What's the Difference?

To help you understand whether you need to consider this type of coverage, let's start with exploring how GAP applies to different types of car purchases.

Car shopping and GAP insurance

"Deciding how much to pay for a vehicle and whether to go new or used, own or lease is an important financial consideration," says Zhaneta Gechev, founder of One Stop Life Insurance. "Most people don't think about how their insurance will change with a different vehicle. They are thinking about the down payment, the monthly payments, the warranty (or no warranty). But knowing exactly how it will affect your insurance should always be a part of the equation. It affects your finances — and sometimes by a lot more than you'd expect." This includes the added cost of GAP.

As Gechev mentioned, you have several options when you are in the market for a new set of wheels: buying a new car or a used car, or leasing a car, rather than buying it outright. How does GAP coverage apply in each of these situations?

Buying new

"New cars tend to depreciate the most quickly, so the likelihood of you needing GAP coverage is higher if you purchase new," says Melanie Musson, an insurance expert, researcher, and writer for carinsurancecomparison.com.

Why?

Gechev explains, "When you purchase a new vehicle, in particular, you can have a pretty wide gap between what your car is worth and what the insurance would cover if the car got totaled."

Buying used

When you buy a used car, you are probably less likely to need GAP coverage. Ryan Guina, founder and owner of The Military Wallet and CashMoneyLife explains, "large gaps between the amount owed and vehicle value is one strong reason to consider quality pre-owned vehicles [instead of new]. After over two years, a significant portion of that initial value loss has already occurred, so you nearly eliminate [the possibility of] owing more than the vehicle is worth."

So buying a car more than two years old means that GAP coverage isn't a necessary cost, in most circumstances, unless you are underground on your loan due to other circumstances.

Creditful CEO Chane Steiner warns, "Be sure to get gap insurance regardless of the age of the car! Any car could be totaled as soon as you get it off of the lot and then all of the money you spent would have been for nothing. You could even end up still owing money on a car you no longer have."

Leasing

Leasing a vehicle is a bit different.

As risk advisor Charles R. Villafana explains, "When it comes to leases, the companies are a bit more rigid with their guidelines, requiring higher limits of liability and GAP insurance. Which in the end is a great thing, just because it takes care of the consumer as well as the companies' interest."

"Sometimes the choice is made for you and you are required to purchase GAP insurance according to the terms of your lease," explains Joel Ohman, a Certified Financial Planner™ and the founder of Car Insurance Comparison. While your lease's terms are likely requiring you to get coverage, it can either be included in your financing deal, or not included.

"As a general rule," explains Mike Scott, a Senior Mortgage Loan Originator at Independent Bank, "GAP is already included in the vast majority of leases done, so purchasing GAP waiver, or GAP insurance is not necessary in those transactions unless you are leasing through an off-brand company."

Steinway advises that consumers be sure to check their lease if they aren't certain.

With these three purchase options out of the way, let's examine just when GAP coverage would come into play.

How does GAP insurance work?

"In a nutshell, Guaranteed Asset Protection — better known as GAP insurance — covers the 'gap' between what you owe on your vehicle and what it's worth at the time of the loss," explains David W. Griffin Jr., Vice President at The Dowd Agencies. "If your car is totaled or stolen, your auto insurance policy only covers what your car is worth at the time of the claim, which may be far less than what you owe. GAP insurance can make up the difference so you can pay off the full balance of the loan."

As Griffin mentioned, this would be a benefit to you in basically two circumstances:

• You get in a car crash and your car is totaled
• Your car gets stolen

What are you risking without GAP insurance?

Basically, all insurance is about risk avoidance. With GAP insurance or waiver protection, what is the risk that you are actually trying to avoid?

Gechev has some insight to understand the heavy financial toll that neglecting this type of coverage can have: "Prior to launching [onestoplifeinsurance.com], I was an assistant manager at a major insurance company. I saw first hand the devastation that could come when people did not have GAP coverage."

"Unfortunately," Gechev explains, "I've worked with many clients who did not have GAP insurance and for one reason or another, the car was a total loss. It might be an accident, it may be stolen. For an insurance company, it does not matter how much you owe on the car, just how much it costs to replace. There were many clients that were 'stuck' paying for a car that they no longer had. It is pretty upsetting when you have to do that."

"In effect, GAP insurance saves you from having to continue making payments on a vehicle that you no longer own," explains Ohman.

What type of problems can arise when you don't have GAP covered?

• No car to drive, but you still have to pay for it. — "GAP Insurance is an important protection," says Drew Scott from Scott Insurance. "Insurance carriers will pay the book value of a car if totaled or stolen. However, that amount may be less than the balance of the loan, leaving the insured with no car and money still owed."
• Two auto loans for one car — If you don't have GAP coverage and your car is totaled or stolen, insurance agent Brandon Tritten from JBLB Insurance Group explains, "you're going to buy a new vehicle and have a loan on your new auto — plus a vehicle you no longer own." That means paying two monthly payments to drive just one car, or wrapping your remaining balance into another loan. Either way, you pay a lot.

What is the alternative to GAP?

If you don't have GAP protection, you have to pay out of pocket for the difference. And who wants to do that?

When weighing your options, it's pretty simple. Tony Matheson, CFP® is a Wealth Advisor and founder of Matheson Financial Partners LLC. He suggests looking at it this way:

"With any insurance coverage, ask yourself 'Would I be able to cover the loss with my savings account?' If the answer is no, then you should consider purchasing insurance to protect yourself from a loss that could potentially devastate your finances. If you don't have the savings to cover a loss, GAP insurance is a good idea.

We see this happen often when the value of the car is lower than the loan or lease obligation. This is often caused by a small down payment on a new car or when you have stretched the loan term out over five years."

How does GAP insurance differ from car insurance?

When you have a car, you are required to get car insurance. What's the difference between GAP protection and what you are already paying for your car insurance?

"Standard auto insurance pays only what a car is worth at the time of a theft or accident," Car Leasing Concierge Paul Maloney explains. With car accidents, Guy S. DiMartino, DC, JD explains this general rule about car insurance: "Whether the claim is made through your own collision insurance or the other driver's property damage coverage, the insurer is only required to pay fair market value for the vehicle."

And they don't just guess what the fair market value is. "Most insurance companies use the NADA program to calculate this actual cash value," says Kelly M. a paralegal at Hancock Injury Attorneys. "This amount is almost always less than what you owe on your lien."

What does this mean for you?

Because the car insurance payout is less than what you owe, Kristine Lee, a licensed insurance agent and content strategist at insurance comparison site, The Zebra, explains that the situation is likely "leaving you in a situation where you're not entirely 'made whole' by your insurer after an accident."

How does GAP insurance help?

"Gap insurance protects you financially if you happen to total your new car, as it fills in the gap between what your insurance company will reimburse you for and what you owe to your lender," advises Lee.

Put another way, "GAP insurance comes to the rescue," says Maloney. "[It] supplements the payout you get from comprehensive or collision coverage if your car is totaled or stolen."

Now that we understand that GAP insurance is mostly needed for newer cars, to cover your financial bases if you can't use your car anymore, let's examine the reasons why you might owe more money to your lender than your car is worth.

Why would you owe more on your car loan than the car is worth?

This can happen due to a couple of different circumstances:

• Taxes, fees, and ancillary costs — "Almost always you would owe more on a car than it is actually worth," says Gechev. "Just think of all of the expenses that are added on the back end: taxes, loan documents, warranties, trade-in balance, depreciation, etc."
• Trade-in wrapped into new loan — A consumer may "owe more on their vehicle than the trade-in value and the dealership wraps the deficiency [from the existing loan] into the new loan …" suggests DiMartino.
• Small down payment — "If you buy a new or newer car with little to no down payment," explains Musson, "there will be a period of time when your vehicle has depreciated and is worth less than what you have financed. So, you have to evaluate if you have the finances to pay that difference if your car is a total loss. If you can, then you can decide if you want to assume that risk. If you can't, then pretty clearly, you need GAP coverage."
• Long loan term — "Generally speaking, if you finance a vehicle over a term of 48 months or more, or you only put a small amount of money down then you should consider purchasing GAP insurance," advises Ohman.

These last two, small down payments and long loan terms contribute to the biggest reason: Depreciation.

What does depreciation have to do with GAP insurance?

"GAP insurance is also important when a car is recently purchased, but no longer considered new," explains Drew Scott. "A vehicle's largest drop in value occurs the moment it is first sold and driven off the lot."

This is critical. "It's critical to realize that new vehicles drop in value as much as 20 percent right after you drive off the lot," explains Gechev. "If you were to get into an accident or the vehicle is somehow damaged or stolen — you owe the difference between what the insurance will pay and what you owe on the loan. That can be a difference of thousands."

Mike Scott from Independent Bank helps us understand how your car's value depreciates:

"A vehicle depreciates the minute it is driven off the lot, and follows a normal depreciation curve, in which a large percentage of the depreciation happens within the first month to six months, and then it levels off as the vehicle depreciates slowly following that.

Why? Well, let's look at new car sales.

Right now (August of 2019), the 2019 double-cab Chevy trucks are being sold for 20 percent off of MSRP. That means that the vehicle you purchased three months ago is being sold for less than you may have paid and is also competing against the new vehicles.

This is by no means exclusive to American vehicles.

Nissan is currently offering $3,500 off of the Rogue in addition to any dealer discounts, BMW is offering discounts of $2,000–$3,500 on most of their models, and pretty much every manufacturer discounts the remaining vehicles at the end of the model year.

What this means is that, unless you placed a very large down payment (30 percent or more) on your vehicle, you probably owe more on it than it is worth.

When we combine that fact with longer-term financing, the curve at which a vehicle is paid off means that we often don't reach a break-even point (the point at which what is owed is equal to the value of the vehicle) until three years or more into a five-year loan. Even financing it at 0 percent interest, you still won't break even for at least 30 months without a large down payment. Can you afford to cover that difference between what your insurance company would pay and what you owe? If not, then getting GAP insurance may not just be a luxury, but a necessity."

Where and how do you get GAP coverage?

GAP coverage can be in the form of a GAP waiver or a GAP insurance policy. These can be acquired in a couple of different ways: through the car dealership's F&I department, through your loan provider, or with a car insurance company.

At the dealership, through your loan

"GAP policies are one of the ancillary products often sold by dealerships in the F&I office (usually at highly inflated prices)," explains Steinway.

Insurance agent Brandon Tritten from JBLB Insurance Group warns, "A lot of dealerships will include GAP insurance in your loan. It is important to ask…

• • Is the dealership or lender offering GAP insurance?
  • What is the cost?
  • Can you opt out of it?"

While GAP costs can be rolled into your new financing agreement, Mike Scott warns, "Keep in mind, however, that the GAP coverage is one of those items which a dealer can mark up considerably. As such, you may have significant room to negotiate the cost." For example, he shares, "On a recent purchase of a $40,000 vehicle, GAP cost my wife and me about $600."

Through your own outside lender

If you are getting outside financing rather than going through the dealership, you can still try to roll GAP coverage into your financing agreement. "Many people don't know, but there are banks that offer GAP insurance built into their loans," says Gechev. "You don't have to pay extra for it. You get the best of both worlds — the coverage you need without paying extra for it. The catch here is that you could not be upside-down on the loan."

From your car insurance company

The third place that consumers can procure GAP coverage is with an insurance company. "A GAP insurance policy is typically sold separately from your traditional car insurance policy," explains Ohman, "though it can often be sold by your existing car insurance company to ride alongside your current policy."

"Generally, most auto insurance companies offer a form of GAP insurance you can add to your policy," advises Tritten. Although, he warns consumers that "It is an endorsement you have to ask for. It doesn't come automatic. Nor is it free."

While most insurance companies do offer some kind of GAP coverage, it isn't a given. Gechev adds, "It's important to note that not all insurance companies offer GAP insurance, so you may also find it necessary to change insurance companies."

Additionally, when adding GAP insurance through your insurance company, there is a time window you should know about. Ohman explains, "Typically you have a 30-day window to purchase GAP insurance after you purchase your vehicle."

However, he suggests that consumers can easily add GAP at the same time they buy the vehicle, because you have to notify your car insurance company that you are adding a car to your policy immediately.

While you do have to secure your insurance within a timely manner, you don't have to keep it forever. Griffin adds, "Remember, though, that the 'gap' [between what you owe and what your car is worth] shrinks as you begin to pay down the loan and the vehicle decreases in value, so you don't need GAP insurance throughout the life of the loan."

"Once you're comfortable with your equity position in the auto you can remove the endorsement from your auto policy," explains Tritten.

When you contact your insurance company about the new car you are adding to your policy, make sure to ask questions. Guina from The Military Wallet, explains, "It's important to note that a lot of insurances now have 'full repayment cost' or 'new car replacement,' so you may not need actual GAP coverage. It's best to calculate carefully and talk to your insurance agent to make sure you're fully covered. Don't assume."

So, which is best? Getting a GAP waiver from the dealership, your bank, or a GAP policy from your insurance company?

"I would weigh the cost of adding the endorsement to your auto insurance policy versus buying it from the lender/dealership," advises Tritten. Knowing the difference in cost will help to make the decision.

It's really just important that you are covered in the case of a total loss. "Wherever you buy GAP," suggests Steinway, "make sure you ask the salesperson the following questions:

• Does the policy include the deductible on your collision or theft insurance?
• Does it include any negative equity or rollover balance from a previous loan?
• Does it exclude cars that are uninsured or underinsured?
• Does it cover interest and fees that build up starting when your car is stolen or totaled until the insurance payment is made?
• Does it include any obligation you may have for window etching or other add on products?"

Experts advise when it is worth it to buy GAP and when it's not

"Both GAP insurance and GAP waivers serve a vital role in protecting consumers' investment in their vehicles," says Danielle M. Diodato, Esq., Associate General Counsel at DOWC® "When GAP should be considered just depends on an individual's circumstances."

She adds, "There is no magic formula to determine who should consider GAP protection, but thankfully for consumers, there are options."

Without a magic formula, we asked the experts to tell us when GAP coverage is worth it, and when it is not. Here's what they said:

When it's worth it:

• "The advice we give to our motor vehicle accident clients is the following: In the majority of cases, Gap coverage is worth it. Gap insurance is VERY inexpensive. If your car is a total loss from an auto accident, the insurance company will only pay you for the actual cash value of your car. The gap insurance pays the difference. This protects the client from having to pay any out-of-pocket or have a rollover into another car." — Kelly M., Paralegal at Hancock Injury Attorneys
• "When leasing or buying a car, compare your total cost, including taxes and fees rolled into the loan, to the car's MSRP and ask yourself the following questions:
  • Do I owe more than the vehicle is currently worth?
  • If I do, could I pay the difference between what I owe and what the vehicle is worth?
  • If the answer is no, then purchasing GAP insurance makes sense." — David W. Griffin Jr., Vice President at The Dowd Agencies
• "It's worth having gap insurance if a) you have a financed or leased car, b) you made a small down payment, c) you're financing long-term, or d) your car's value depreciates quickly while you still have a loan. In instances where you're potentially in a position to lose money because of the financial gap of what you owe versus the value of your car, it's prudent to have gap insurance to cushion the blow if the vehicle is totaled." — Kristine Lee, The Zebra 
• "You should get GAP on any purchase in which you are not putting a significant (30% or more) down payment on the purchase of the vehicle, particularly if you are also financing the vehicle for an extended period of time." — Mike Scott, Senior Mortgage Loan Originator at Independent Bank
• "If the vehicle purchase is financed, it is ALWAYS appropriate to get GAP insurance. GAP insurance is priced very reasonably, and like any insurance product, it is priced actuarially, reflecting the quantitative risk to the insurer. If the negative equity resulting from a total loss results is minimal, the premium will be very low. If the resulting negative equity would be great, the premium will reflect that, and the buyer is relieved of the responsibility for that loss. There is simply no decision to be made. It is extremely disheartening to have no vehicle but continue to have a car payment." — Rob Drury, Executive Director, Association of Christian Financial Advisors
• "A car buyer that can only make a small down payment or needs longer financing terms — up to 84 months — is a prime candidate to consider GAP protection." — Danielle M.Diodato, Esq., Associate General Counsel, DOWC
• "The purpose of GAP is to cover the difference between what your car is worth and what you owe on your loan. So anything that increases that gap — either because you borrowed a lot more than the car was worth or because the car lost its value more quickly — will make GAP more valuable.
  If you can buy it at a reasonable price, we recommend purchasing GAP if...
  
  • Your down payment was less than 20 percent of your total loan.
  • You drive more than 15,000 miles/year.
  • Your loan amount is greater than the value of your car because you financed your fees, taxes, negative equity or rollover balance from an older car loan, a vehicle service contract, or other items.
  • You bought a vehicle that is likely to lose its value, or depreciate, more quickly than the average.
  • Your loan term is 60 months or longer." — Sonia Steinway, CEO, Outside Financial
• "Gap Insurance, in my opinion, is a very important part of your insurance coverage, especially when auto dealers offer the zero to little money down and longer financing terms. Driving off the lot the car will not appreciate, but depreciate in value, essentially creating a loan-to-value gap. This the most important time to have the coverage in place." — Risk advisor Charles R. Villafana

When it's not:

• "Insurance companies make money by providing insurance. If you can self-insure yourself with an emergency savings account, that is the best option." — Tony Matheson, CFP®, wealth advisor and founder, Matheson Financial Partners LLC.
• "If you make a large down payment or purchase an older car for a good deal, and you know you won't be upside down on your loan, then clearly, you can forego GAP." — Melanie Musson, insurance expert, carinsurancecomparison.com
• "The ONLY way you DON'T need GAP is if you had put in a big down payment or if you owe less than what your vehicle is worth." — Zhaneta Gechev, founder, One Stop Life Insurance