Many years ago, I worked with an old engineer who always wore a belt and suspenders. Always. One day I pointed out that fashion snobs consider a belt and suspenders to be a serious sartorial faux pas.
He was unimpressed.
“I know,” he said, “But I’m allergic to risk.” That remained a running joke between us until he retired a few years later.
Some people believe that guaranteed asset protection (GAP) insurance is overkill too, but that’s not necessarily true.
What is GAP Insurance?
GAP insurance covers the difference between what you owe on your car and what your insurance company would pay if you get in an accident and your vehicle is declared a total loss.
Usually, when you get in an accident and your car is declared a total loss — or your car is stolen and never found — your auto insurance company pays the car’s blue book value minus your policy’s deductible.
Of course, there’s a catch: If the car’s loan or lease balance is more than the market value of the vehicle, then you are on the hook for the difference; it’s a scenario that’s typically — but not always — more common early in the life of a new car. For example, according to Edmunds, a brand new Nissan Z loses 9% of its total market value in the very first minute it’s driven off the lot; after one year, it’s 19%.
So, with that in mind, let’s assume you buy a brand new Nissan Z for $45,000. Let’s assume after adding taxes, license and insurance, the car’s cost increases to $50,000. If you used an auto loan to cover the entire amount, and then got in an accident five minutes after driving your brand new Z-car off the dealer’s lot, this is how your insurance company would settle up with you:
Market value of your car: $40,950 (assuming 9% depreciation)
Less deductible: $1000
Insurance proceeds to you: $39,950
Outstanding loan amount: $50,000
Less insurance proceeds: $39,950
Amount you owe the lender: $10,050 (!)
I don’t know about you, but if I was stuck having to write a check to my lender for $10,050 after my car was totaled through no fault of my own, I wouldn’t be a happy camper. The good news is GAP insurance would cover that amount.
Reasons for Buying and Avoiding GAP Insurance
There are other reasons to consider buying GAP insurance. For instance, if you:
- Finance your car for more than 4 years
- Lease your vehicle
- Purchase a new car with a history of high depreciation rates; especially budget-friendly subcompacts
- Put less than 20% down
- Drive more than 15,000 miles annually
- Borrow more than the purchase price (usually to cover tax, license, insurance, and other extras)
On the other hand, you probably don’t need GAP insurance if:
- Your car’s market value far exceeds the value of the loan
- Your loan is less than 24 months
When I bought my new Honda Accord, I purchased GAP insurance from my auto insurance provider; the rate was $27 every six months and the price came out to 10% of the collision and comprehensive insurance premium. However, depending on the insurance company, that figure can be as low as 5%.
The Bottom Line
For what it’s worth, I didn’t renew my GAP insurance after the market value of my Accord exceeded the amount I owed on the vehicle. In total, I spent less than $100 for the peace of mind that came with my GAP coverage while I was “upside down” on my car loan.
Yes, in many cases guaranteed asset protection is the insurance industry equivalent to a belt and suspenders — but there are also plenty of scenarios that can leave you financially vulnerable without it. Keep that in mind the next time you buy a car — especially if you’re the type of person who is allergic to risk.
Photo Credit: StewC
We don’t have gap insurance, but something bad did happen to my friend years ago that is related to this. Someone hit her car (the person who hit her was uninsured) that she had just bought. She didn’t have gap insurance, and the car was worth WAY less than what she owed. It was a horrible situation and she had to pay a lot of money out of pocket all for something that was someone else’s fault 🙁
Sad story. The fear of that kind of scenario striking me is exactly why I decided to carry GAP insurance for the first two years after I bought my new car, Michelle.
That’s nice that you were able to get it through your insurance company, and that you can just drop it off once you don’t need it anymore. I’ve seen people pay up to $1,000 to a dealership for it and some of the time, the gap insurance provider doesn’t pay the full gap.
Whoa! A thousand clams is wayyyyy too much for GAP insurance, Ben. Anybody selling “GAP insurance” that doesn’t cover the gap is committing fraud, IMO.
I used to work in auto collections before it all was sent overseas. I used to tell customers that the way to figure out what YOU can truly afford to spend on a car is to do this:
First, make the car payment you are planning on assuming into your savings account for six months. If you are late with a payment, you know you cannot afford that much.
Second, take the accumulated amount and use it as a down payment and hopefully add a little extra to it.
Third, once you buy your car, get one month ahead on the payments ASAP. Once you are ahead then start adding a $10-30 extra payment to principal every month. Keep doing this until loan is paid off-months earlier than contract requires.
After reviewing literally thousands of accounts where customers had debt payment problems I can say that this plan works for those who are trying to get ahead.
Car sales and financing work together to try to keep you in perpetual debt. If you follow their payoff schedule you can almost bet that there will be an expensive repair needed about 6-12 months BEFORE that car is paid off. Most people who are struggling end up trading and getting another cycle of debt. I saw it every day for years. But if you pay that little extra to principal it totally changes your situation and as I have asked many folks…can you tell me what the downside is to being ahead?
Great tips, Deb. I had no idea that collections were moved overseas too. Sheesh. I guess nothing is sacred anymore.
We save up and pay cash for our cars…..then get 10-15 years out of them (my pickup is 2003, her Subaru is 2011…..both have plenty of life left in them). Doing so avoids interest and gap insurance. It’s just as easy to pay yourself in a separate ‘car fund’ as it is to pay a bank for the privilege of allowing them to create money out of thin air.
As for suspenders and belt, I often wear that combo….suspenders to hold up my pants, and a belt to hold the holster for my Glock.
Here in WV, uninsured driver insurance is required, but the minimum amount required is low. Higher coverage must be offered as an option, also by law.
Needing GAP insurance is another reason to buy a gently used car and pay cash for it. Loved Deb’s note about how to get ahead on car purchase. Just bought my new van for cash and continue to have $200./ month automatically deducted from my checking account by an online bank. In ten or twelve (or more sometimes) years when it is time for a new van, the money is there. My 2005 van is still with us, use it within a 50 mile radius of home because AAA gives a free tow of 50 miles or less. Keeps me from wearing out the new van which is used more for longer trips and when I really don’t want to risk missing an appointment. For driving locally the old van is great, and when it dies it will be towed home free by AAA, and then donated to anyone who wants the well used remains. The old van is great for hauling dirty stuff.
Hi Karen,
You are lucky, my AAA only give free towing for 2 miles , I pay extra for premium which is 100 miles
Len, please write an article on Car Insurance coverage for peer to peer rentals such as TURO. It is very complicated depending on the State. Not that one intends to use the insurance but if needed it is complicated. Often involving several insurance companies.
Here, we have single payer Govt auto insurance which is a fraction of what private insurance companies charge in other provinces. However, when I bought a brand new spanking truck for cash just over 2 years ago I added on what we call here full replacement coverage, which means I get a new truck out of it with no depreciation factor if I get into an accident. I haven’t bought a new vehicle for 50 years…(age 70 now), but I got fed up repairing old vehicles and we need reliable transport as we live very rural and have no other transportation options. One reason I got it is that a friend of mine totaled her vehicle about 1 month before her replacement insurance was to run out…5 years in on her ownership. It was not her fault in the slightest. She replaced it with new. Without the add on we just get paid out at blue book if we totaled. Bought a Nissan Frontier and love it…especially when we have snow like today.
One reason why our insurance is so affordable is that the Govt passed a law mandating no fault auto insurance which got the lawyers and litigation out of the market. My premiums dropped 30% overnight because of it. If you have a serious claim it goes to a tribunal for resolution and stays out of the courtroom.
That’s odd; “no fault” insurance usually raises rates for responsible people because it shifts the burden away from the person who is at fault, to EVERYONE – including those who AREN’T at fault. It’s essentially socialism on a small scale – higher costs for those who are self-reliant and financially responsible.
My rule to live buy: never borrow for assets that do not appreciate in value. Problem solved. (See Suburu and truck commenter)
That’s a good rule to live by, Kevin!
No, no, sooo no. Even considering GAP insurance is a sign you really cannot afford the car. If you can’t pay cash you can’t afford a new car. If you can afford a new car, the cost of a GAP, should bad luck happen, should be a minor expense for you. If not, a sure sign you are not financially ready for a new car. Use the Ramsey method if buying used cars and saving until you can afford a new car cash. Even then it is not a good deal. A new car is a luxury expense for those who have made it financially.
I miss Mr. Dave every time I see one of his old posts.
When he married a second time, he had gap insurance. His first wife was in heaven, and his second wife was on earth. For the time being, the gap was far enough in between. hahaha