Do You Really Need That Gap Insurance Policy? Yes, but... (what the dealership doesn’t want you to know)

So you finally found your dream car (or something close to it that you can afford). You’ve done your homework and you’re pretty sure you’ve got all your ducks in a row. You took the test drive, shopped around for a fair price, got approved for a loan with terms you can live with and a budget friendly interest rate, and you’ve made arrangements to get the right kind of insurance coverage. Ready to sign the paperwork and speed off into the sunset? Now, hold on there a moment, hot foot! Shift it into reverse. Before you walk into that dealership’s business office or sit down in front of their business manager’s desk to sign all the paperwork and seal the deal, we need to talk. Let’s have a little chat about ‘gap’ insurance, ok? Chances are, they’re gonna bring it up. And, if you are new to the car buying game like I was, they’ll assume that you don’t know what I now know (and am going to share with you below). So let’s prove them wrong, shall we?

You see, last week, my husband and I were the “you” in the scenario above. If only we had a time machine. We could have saved ourselves the inconvenience of driving back over to the dealership the next day to cancel the overpriced gap policy we had naively bought; the one we were led to believe was the one ‘extra’ thing truly smart car buyers buy, that we were told was a “good deal” (at only $13 a month, which could be effortlessly rolled into our monthly car payments) compared to totaling the car and ending up upside down with our payments because our regular insurance would not cover the difference between the depreciated value of the car and what we still owe, and that we “couldn’t get anywhere else.”

Thankfully, they let us cancel the darn thing, but only after feigning surprise at how we were able to “find” another gap policy through our regular insurance provider—at a small fraction of the cost, by the way. I don’t know if all dealerships would have allowed us to back out after we’d already signed the contract. You might not actually be so lucky. So please, if you fall into any of the categories I’m about to spell out below and you are a first time car buyer, please read on and learn from my/our mistake. If you’re a seasoned veteran of the car buying scene you might not need to continue reading any further. However, regardless of how many cars you’ve bought and financed, if you’ve been faithfully paying for gap coverage through your car dealership, stick around. You, my friend, along with the newbies, are also part of my intended audience.

Now that we’ve established who should be reading this it’s time to talk turkey--or ‘turn-key,’ as in, heed my advice so your car buying experience is essentially turn-key instead of fraught with hang-ups and regrettable moments. Let’s start with the most basic and, really, most important question.

Do I need to buy gap insurance?

The answer is “yes” if you:

• will be leasing* or financing the purchase of a new or nearly new pre-owned (aka, "used") car, truck, etc.
• are about to buy a very expensive mid-life-crisis-mobile (i.e., a pricey luxury vehicle)
• will have to finance your vehicle for 60 months or more
• will only be able to make a relatively small down payment (less than 20% of the total cost) toward your new vehicle, which creates a "gap" between its actual value and the amount of the loan
• don't have enough in savings to cover that so-called gap if your wheeled baby gets stolen or totaled, or do have it but aren't willing to risk sacrificing your vacation fund or other cash you've worked so hard to save for any purpose         

*Please note, gap insurance is required by leasing companies, so it will probably be included in your contract. If not, shop around and/or ask your insurance agent. If gap coverage is included in the contract, find out how much it will cost. Some lease contracts include a waiver that will protect you in the unfortunate event that the vehicle is totaled, which would mean that you don’t actually need a formal gap policy.  

What, exactly, is gap insurance and why do you need it?

Gap insurance is, as I mentioned earlier, a policy some folks (see bulleted list above) should definitely consider purchasing to make up the difference, or the gap, between what a typical auto insurance policy will pay for in case of theft or accidental demolition of your new vehicle and what you actually owe on the vehicle at the time it bites the dust. So it’s aptly named in reference to a literal gap in auto insurance coverage, but the term “GAP” is really a clever little double agent, also functioning as an acronym for “Guaranteed Auto Protection.”

Typical auto insurance policies will reimburse you only for the current market value of your vehicle at the time of a theft or an accident in which your car is “totaled.”  And basically, if your car gets stolen or totaled within the first two years of its life, it will not be worth anything close to what you still owe on it. This is due to depreciation, in which cars start losing their value, or “depreciating,” as soon as you drive them off the lot. Edmunds.com estimates the rate of depreciation is roughly 30% in its first year and 20% in its second year. By the time your precious auto baby reaches its third birthday it will only be worth half of its original value!

Here’s how gap insurance works. Let’s say you buy a new car for $25,000 today. About one year later you get t-boned, while pulling out of a carwash one beautiful sunny day, by a teenager driving too fast in his daddy’s Hummer, too busy texting his girlfriend to notice the red light he just blew past. Guess how much your insurance company will pay to replace that now useless hunk of metal? Probably somewhere in the neighborhood of $18,000. That means, depending on how much your down payment was, you have a gap of up to 7,000 bucks that you’ll still owe on your auto loan (not to mention, no one’s gonna give you back the $25 you just wasted on the Super Deluxe Wash ‘n Wax). But, if you have gap insurance, the insurance company will pay the remaining $7,000 on your loan. In other words, you will not have to pay another dime for a car that is dead to you.

Now you’re probably thinking something like, “That sounds great! Sign me up.” And I would not stop you, my intrepid car buying comrade. That is, unless you are saying that to the business manager (or whoever handles financing and contracts) at the car dealership. Before I can give you my blessing to “go forth and cover the gap” I need to tell you one more thing.

DO NOT buy the gap policy at the dealership!

The only exception to this directive would be if you’re the kind of person who enjoys throwing money down the toilet for no logical reason. But, you’ve chosen to read this article, so I seriously doubt you’re that kind of person. Anyway... Had we not questioned the plan we were sold and left our contract as it was the night we drove off the lot in our new car we would have ended up shelling out $936 over the course of our loan, plus interest, for a gap policy we were able to easily get through our regular insurer for only $34 a year. All we had to do was ask our agent. Furthermore, a simple Google search showed us that, contrary to what we were told by the people at our dealership, just about every major insurance company has gap coverage available. Of course, they didn’t want us to know this because selling gap insurance is an easy way for dealerships and their salespeople to make a nice profit, with commissions of up to 50% of gap policy premiums. So it pays to simply ask your insurance agent to add gap coverage to your existing policy, or better yet, ask if you even need it at all. Some regular insurance policies actually cover the fully financed amount.

Now, go forth and cover the gap!

Sources: bankrate.com Edmunds.com, trustedchoice.com