Do I Really Need Gap Insurance on My Auto Loan?

If you’ve ever purchased a new or used vehicle through a dealership, you’ve been offered Gap Insurance. (By one name or another)  Gap Insurance, also known as Total Loss Protection, TLP, or Guaranteed Asset Protection is basically what pays off the balance of your loan when your insurance comes up short after a total loss.  In this post, we’re going to explain what Gap is, what it does, when you need it, and where to get it.  

What Is Gap?

When you total your car you file an insurance claim.  The insurance company determines the value of your vehicle and writes a check for the amount that they determined the vehicle was worth.  This is such an important fact that I’m going to re-state it.  Your vehicle is insured for the value of the vehicle, not necessarily the amount of your loan.  This is where Gap comes in.  To better explain, let’s look at an example: 

In this example, Joe and Theresa are expecting their first child, and need a vehicle that is a little more child-friendly than their existing car.  Safety and convenience being huge factors in their decision, they decide upon a new sedan for the new baby.  With only three months left in the pregnancy, they’re pressured to buy soon, but other expenses keep them from having the money they want for a down payment.  Not to worry! Because they have excellent credit, their salesman tells them that they can get the car with no down payment.  They’re purchasing their new car for $25,000.  For the sake of ease, we’ll say that the vehicle is also valued at $25,000.  After adding tax, title, and fees, they end up financing $27,749 on their new vehicle.  

Four months later, a standard Florida Driver blows through a red light and glances off of the front end of the new car.  No one is hurt, but the car is totaled.  Joe and Theresa aren’t worried because they have full coverage insurance with only a $500 deductible.  They file their claim with the insurance company and hapilly go about their business in the rental car provided by their policy.  This easy experience quickly turns into a nightmare the following week when the insurance company calls them and says “Great News! Your claim has been processed and the check for $22,000 is on its way to the lender.”  Wait… What?  

They’re about to find out that, since the car is now a used car with 5,000 miles on it, it was valued by the insurance company at $22,000.  Despite the three payments they made on the car already, Joe and Theresa still owe almost $27,000 to the bank! Why? Because at the beginning of the loan, the majority of their payments went towards interest and they financed items above and beyond the actual price of the car. (Tax, tag, title, fees)  Now they’re left trying to figure out how they’re going to pay the $5,000 difference created by the depreciation and the overage in financing.  

Alternate Ending

If our young couple had purchased Gap Insurance at the time of the sale, the difference would have likely been paid in full, allowing them to proceed to their next car unscathed.  Some Gap policies would have even paid the deductible for them, allowing them to move on with their lives without taking any money out of pocket!

Do I Have to Buy Gap Through the Dealership?

No, but in most cases, you should.  Many businesses are trying to capitalize on Gap, including insurance companies and credit unions.  If you’re financing through your credit union, rather than using dealer financing options, then that’s where you should go for your Gap.  When the Gap is included as an addendum to your loan contract, it can’t be taken away by anyone other than you.  That’s why I don’t recommend getting it through an insurance company.  Insurance can change what they do and how much they charge at will.  They can drop your policy completely or change the amount they charge you for Gap Coverage at any time.  When you purchase it through the dealership, you’re paying a flat fee for it and then it’s broken down into the monthly payment.  It can’t be canceled unless you cancel it.   

If I Put Money Down, Do I Still Need Gap?

This is where things get a little more complicated.  The answer is: It depends.  It depends on how much you’re putting down, what kind of depreciation rate the vehicle you’re purchasing carries, and what the vehicle is valued at when you purchase it.  If the dealership is ripping you off by selling you a car for $5,000 more than it’s worth, your down payment may not be sufficient to keep you out of the hole if it’s totaled.  

Do I Need Gap If I Lease?

Most lease companies have Gap insurance built into the lease terms.  This is something that you need to verify at the time of purchase.  If it’s not part of the lease, then you should definitely consider adding it.  

Insurance Company Ads

A few insurance companies have started advertising that they pay for vehicle replacement rather than the value of the car in the event of a total loss.  Some have benefits similar to a Gap policy and some are a marketing ploy that will leave you hanging.  Read your paperwork from both the dealership and the insurance company.  Once the accident occurs, it’s too late to make a change.

Differences in Gap Policies

You need to be aware that there are variations to Gap coverages.  These include things like price, duration, loan to value limits, and limits on how low the insurance company can go on their appraisal.  It is vital that you read over your policy contract before you sign it.  Ask the finance manager or salesperson questions and don’t sign until you’re satisfied that you’re getting what you need.  If you’re in Florida, you have the right to take your paperwork home and read it over-night before signing.  

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Disclaimer: The example in this article is fiction. Names, characters, businesses, places, events, and incidents are either the products of the author’s imagination or used in a fictitious manner. Any resemblance to actual persons, living or dead, or actual events is purely coincidental.