I received a great question from Dan today.  Dan asked whether GAP insurance is a good idea.  Before we get into the question at hand I will take this opportunity to explain what GAP insurance is. I have seen several acronyms for what GAP stands for, but it really is just that, insurance that bridges a gap. When you buy a new car the value of that vehicle is negatively impacted the moment the registration application is processed. It is often said that the vehicle loses value as soon as you drive it off the lot. While the sentiment is true, the reality is that the car becomes a used car the moment the car is titled. So technically that drop in value doesn’t occur instantly. But I digress.

The principal of GAP insurance on a new car purchase is that in the event that the car you bought is stolen or wrecked, the GAP insurance will pay the difference (or “gap”) between what you owe on the vehicle and what the market value is of the car. This is important to know because the nature of automotive financing is that as an amortized loan the majority of the payments in the beginning of the loan are mostly interest. So you may have made a years worth of payments and you still owe as much as you borrowed initially. This is sad but true. The insurance company, who you faithfully pay every month, wants to pay out as little as possible for the loss. So depending on the type of car and the specifics of the car buying deal the difference between the insurance payout and the auto loan could be substantial, up to and sometimes exceeding 20%. So on a $30,000 car, the gap could be over $6,000. Without GAP insurance this is money you owe the bank. They do not care where the car you bought is or what happened, they want to be paid.

I have seen people that have destroyed their credit by not making good on this obligation. It is very tough to tell someone who has no car that they can’t buy a new car because of this situation. I have also seen a person who was able to buy a new car but needed to tack $9,000 onto the loan for the gap on the car that was stolen. That equates to about $180 extra a month. Just because they didn’t buy GAP insurance.

So back to the question, is buying GAP insurance on your new or used car a good idea? First of all, GAP insurance should cost between $250 and $500. Any less than that, be skeptical. Any more, tell the dealer to go fly a kite. Or whatever words you want to use.

Buying GAP insurance is a good idea if you are financing or leasing a car, truck or SUV with little or no money down. If you are putting down more than 20% PLUS taxes, title and license then it becomes less of a benefit and I would probably skip it unless you are buying a car that is known to lose its value quicker than most.

If you have ANY negative equity that you are rolling into the transaction without a doubt get GAP insurance.

I have seen dealers sell GAP to people who pay cash for a car, this is basically stealing. Do not fall for that one. If this happens to you or someone you know, demand a refund. If they resist, the Attorney General of your state would love to hear about it.

Another thing to know about GAP insurance is that it is cancellable. Meaning if you sell the car before you pay it off there may be a pro-rata amount of the cost that you can recoup. Call the GAP company to find out.

CONSUMER ALERT: Many auto insurance companies are now selling GAP or something similar as an addon to car insurance policies. I would not recommend this at all. This is a huge conflict of interest. Because they are determining the value of the car and therefore the size of the gap, you could be in the position where they decide to fix a wrecked car that should be totalled because it is cheaper for them. You don’t want to end up in an unsafe or worthless car because your insurance company fixed it when they should have sent it to the scrap yard.

Dan, I hope this answered your question and that other car buyers out there can benefit from this post. Thanks for reading the Intelligent Auto Guide.

This entry was posted on Thursday, January 22nd, 2009 at 6:48 pm and is filed under Car Buying Tips, New Car Buying, Used Car Buying. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.