GAP Protects You From Paying For A Car That No Longer Exists
Some people think that extra car protection like GAP insurance is unnecessary. After all, if your car is totaled or stolen, your insurance company will write you a check for the car. At least, it won’t affect you financially, right?
Actually, when a car is totaled or stolen, the owner’s insurance company will usually only pay the owner for how much the car was worth on the market, not how much the owner still owes on the car.
So, if you owe more on your car than it is worth, then you could be stuck making payments on a loan for a vehicle that no longer exists. Unfortunately, since cars depreciate in value quickly, this outcome is not uncommon for car owners. But with GAP Insurance, you can protect yourself from this kind of loss.
OWING MORE ON YOUR CAR THAN IT IS WORTH
The balance on your car loan and the value of your car do not decrease over the years in lockstep. Rather, they largely move independently of each other, creating risk for car owners.
Cars tend to depreciate quickly, but because of how car loan interest works, you pay down your car loan at slower rates early in your car loan. The result is that many car owners find themselves with car loan balances that are greater than their cars’ market values (also known as being “upside-down” or “underwater” in a car loan).
The factors that determine the market value of your car are complex. Your car’s condition and mileage, of course, play a role in its value but so do factors like the supply and demand for cars like yours in the used car market. So, car depreciation is both volatile and hard to forecast.
However, at any one time, a large number of car owners are “underwater” or “upside-down” in their car loans. And since it is not possible to accurately predict what your car will be worth years or even months into the future, you may end up underwater in your car loan at some point. GAP protects you when you are underwater in your car loan.
HOW GAP INSURANCE WORKS
GAP Insurance, or “Guaranteed Asset Protection,” guarantees that you will not lose money on your car if it is totaled or stolen. Remember, insurance companies will only cover your car up to what it is actually worth. So, if your car is totaled and you owe more and your car than it is worth, you would be stuck paying for a car even after your insurance cuts you a check for the loss. GAP will cover the difference between how much you owe on your car and how much your insurance company pays you (you could say that it covers a gap in your insurance coverage).
Additionally, most GAP plans will also give you up to $1,000 to pay your insurance deductible, so that you will not have to pay out-of-pocket to get your insurance money.
One of the big advantages of GAP is that it can help protect car owners from building “negative equity,” or debt from an old car loan carried into a new one. Without GAP, if your car is totaled and your insurance payout does not cover the full balance on your car loan, you may have to roll the remaining balance into your next car loan. Not only would this mean having more debt, but it would also put you at greater risk of being underwater in your new car loan. But if your car is totaled and you have GAP, then your old car loan cannot follow you into your next one.
EXAMPLE: GAP INSURANCE AND YOUR TOTALED CAR
Suppose you buy a car for $25,000. You finance your purchase with a 60-month car loan with an interest rate of 10%. For 36 months, you make your payments regularly so that your loan balance falls to roughly $11,510 (if you want to know how to calculate this number read about how car loan interest works here).
Then, through no fault of your own, your car is totaled. After 36 payments, your car is no more, and, worse, the insurance company tells you that it was only worth $9,000, so that is all they will cover after you pay your $1,000 deductible. You will still owe your auto lender $2,510!
But you purchased GAP Insurance when you bought your car and rolled its cost into your car loan. So, your GAP provider covers your $1,000 deductible and takes care of the $2,510 you still owe on your loan, protecting you from having to pay out-of-pocket or roll any negative equity into your next car loan to cover your losses.