Gap Insurance
Not everyone is familiar with gap insurance or its importance. Any time you owe money on a vehicle, it's important to consider purchasing gap insurance, so in the event of an accident or theft, you don't have to pay for something you no longer own.
Before you do anything else, you must answer the question, “What is gap insurance?” If you have never financed a vehicle in the past, you may not be familiar with this essential product and what it can do for you. It is by no means a frivolous expense when you are purchasing a new vehicle on credit. What gap insurance does is protect you from having to continue payments on a vehicle that is no longer in your possession due to theft or an accident. That leaves you free to purchase a new vehicle without being obligated to pay off the previous loan, or add it to the cost of a new one.
The value of a car drops so quickly that you are playing devil’s advocate to even consider leaving the dealer’s lot without purchasing gap insurance. Even if you make a substantial down payment, there is a good possibility that if you are involved in an accident or someone steals your vehicle, the insurance will not cover the entire balance you owe on it. When you owe on a vehicle, you will have to pay any deficiencies the insurance company doesn’t cover—this is where gap insurance plays an essential part. Gap insurance will cover the balance of the loan remaining after the auto insurance pays its part.
Do not think for a moment that you can live without gap insurance when you owe on a vehicle. You may think you paid a substantial down payment that will always leave your loan balance less than the book value of your vehicle, but that depends on many different factors such as the length of the loan, how well the vehicle you purchase retains its book value, and how well you maintain your vehicle. Unlike your home, your vehicle will lose value over time, no matter how well you maintain it. Luxury vehicles may retain a higher value, but they will still lose value as time passes.
Most people cannot afford to buy a new vehicle and pay off a deficiency balance on one that has been totaled in an accident or stolen. You must keep in mind that even with insurance, you will also receive the book value unless you pay additional premiums that some carriers offer for replacement value. That means you stand a good chance of having a balance on your vehicle after the insurance has settled your claim. If you elected to pay for gap insurance when you bought your vehicle, any remaining balance on your loan will be covered by the insurance. Unlike insurance, it will not cover a set amount, thus if there is no deficiency balance after insurance, there will be nothing for the gap insurance to pay.
When you are trying to budget the payments for your new vehicle, you may question the feasibility of purchasing gap insurance. How much is it going to raise your payments and is it worth the cost? If you have never had an accident involving a total loss or had your vehicle stolen, you may be thinking you can do without the additional cost of gap insurance. The trouble with that type of thinking is in the fact that one can go years and never have an accident or had his or her car stolen and things change.
The cost of gap insurance is minimal when you consider the repercussions that you will encounter if you find yourself in a situation where you need it. After purchasing a new vehicle, there is no adding the gap insurance later. Although some dealers may allow you a time frame where you can add the gap insurance, you will need to pay cash for it just as you do extended warranties if you choose to make the purchase after the contract is submitted to the bank. You would not purchase a home without homeowners’ insurance, nor should you purchase a new vehicle without both automobile insurance and gap insurance. You are taking a chance with your financial well-being if you fail to purchase gap insurance.
When you are purchasing a new vehicle, the salesperson will probably ask you if you would like to purchase gap insurance on your vehicle. As we have already discussed, gap insurance will pay any remaining balance due on your vehicle after your insurance pays for a total loss due to an accident or theft. It is not usually necessary for the policyholder to contact the carrier of the gap insurance—the financial institution will usually do that for you once they receive notification from the auto insurance carrier how much they are going to pay. They will then submit a claim to the carrier of your gap insurance to recover the remainder of the balance of your loan.
Although the purchase of gap insurance will not provide any funds for you to purchase a new vehicle, you will not owe any additional money on the vehicle you can no longer drive. Between the payment from the insurance company and the remainder from your gap insurance, you will not be obligated to make any more payments on your vehicle. It may not be the best situation because you will still need to fund your down payment for a new vehicle, unless your credit score is high enough to quality you for a loan with no down payment, but you will not have to add the previous loan to a new loan.
Gap insurance is not something you purchase from your own insurance carrier. In most cases, it depends upon the dealer and the financial institution. That doesn’t mean there is only one carrier for this type of insurance, but when you are purchasing a new vehicle, you will make the purchase of gap insurance at the same time you sign the sales contract with the bank. If for some reason the bank limits you to a specific dollar amount and you are unable to include gap insurance within that amount, you can purchase it by adding more down payment to cover the cost or buying it separately.
Gap insurance is essential when you owe on a vehicle. If there is any way you can avoid it, do not purchase a new vehicle without gap insurance. Some dealers will give you up to 30 days to purchase gap insurance, so if you can’t purchase it right away, ask if you have some additional time to secure the funds. Aside from auto insurance, gap insurance is the most important coverage you can purchase when you owe on a vehicle. It is more essential if you purchase your vehicle with minimal down payment since you will drive off the lot owing more money than the car is worth.
For those who have an auto insurance policy that offers replacement cost, it may seem more logical to exercise that option instead of purchasing gap insurance when you owe on a vehicle. Although that may seem like a viable option, you have to weigh the cost factors. In most cases, the gap insurance is going to have a substantially lower cost because it is a specialized short-term insurance policy intended only for the benefit of the lender. On the other hand, an auto policy with replacement cost has no relevance to the lender other than how it relates to the coverage of a lien holder on the policy.
Gap insurance will pay only what the insurance doesn’t cover to pay your loan in the event of a total loss. If you have auto insurance with replacement cost, it doesn’t matter what the balance of the loan is, you will receive the replacement cost of the vehicle less the amount of your loan. Although this method is more likely to provide you enough funds to make a down payment on a new vehicle, it is also more likely to have a higher cost than gap insurance since it is for the benefit of the policyholder and not the lender. In addition, not all insurance companies offer this option.
In most cases, the cost of the gap insurance will be included in the cost of your loan. In cases where you don’t qualify for enough funds to cover the gap insurance, there are other options you can exercise in order to obtain this essential coverage. One option is to pay a larger down payment in order to allow your loan to accommodate the cost of gap insurance. Since many lenders don’t like to see down payments made by a credit card, if you don’t have cash, you may have to work with the dealer to pay for the gap insurance separately, or take a cash advance on your credit card so you present it in the form of a check or cash payment.
You may also talk to the lender to ask if they will be willing to increase the amount of your loan to accommodate the gap insurance. It is in their best interest to provide enough funds to accommodate this essential product, but it depends on both your credit score and the ratio of the loan to the vehicle’s value. If your credit score is high, but the loan to car value ratio is too high, the lender may be willing to offer a personal loan to cover the cost of gap insurance.
When you buy your vehicle, the cost of gap insurance is based upon the length of time you need gap insurance to cover the loan balance and the amount of the initial loan. Does that mean if you pay the vehicle off early, you will have an option to use those funds for a total loss that occurs after you pay off the loan? No, the gap insurance is only available during the time you owe on a vehicle. If you pay the loan in full, the lender will cancel the policy for you and refund any unused portion of the premium.
On the other hand, if you pay off your loan as agreed without needing to use the gap insurance, you do not receive a refund of the policy premium. You pay for a specific period of time, namely the term of the loan, and when your loan is paid in full, the gap insurance expires. In fact, in most cases, if your car payments go into default, so does the gap insurance, so even if your vehicle does not go into repossession, you may lose your gap insurance if you default on the payments. If you extend the term of your loan without actually refinancing (payment deferment), you may also find you have no gap insurance for the remaining few months of your loan.
Gap insurance is essential if you owe on a vehicle. There is nothing more important when you are purchasing a vehicle than obtaining insurance to cover the remainder of the loan in the event of a total loss. By electing to purchase gap insurance, you can prevent a financial calamity when you have to pay off an existing loan for a vehicle you no longer have in addition to having to obtain funding for a new vehicle. Although gap insurance won’t help you fund a down payment for a new vehicle, it will prevent you from having two vehicle loans, or from having to add the balance of the previous loan onto the new loan.
When you begin purchasing a new vehicle, allow enough funding options to purchase gap insurance. Even if you have never had a total loss, do not assume you never will and take a chance. It is much better to pay for coverage you never use than to need the coverage and not have it available. There is a limited period after you purchase a vehicle to add gap insurance, usually 30 days or less depending on the dealer, while some dealers don’t offer any options for purchasing after the original contract is signed. Make certain you make the right decision about gap insurance when you owe on a vehicle.