If you have a financed car or are going to contract one, you might run across the term of GAP Insurance. This article will explain you what it is, and whether or not you need it.
GAP stands for Guaranteed Auto Protection or Guaranteed Asset Protection. A GAP insurance policy will cover the negative equity, i.e. the difference between what you currently owe on the car and its current market value. It may sound complicated and fancy, but it’s not. Here is an example that should explain the concept.
Assume you have contracted a $36,000 car which you are going to pay in 36 monthly installments of $1,000 each. After half a year, you have an accident and the car gets totaled. Your Collision or Comprehensive policy kicks in, so you would be technically reimbursed for your loss. However, the insurance company evaluates your car and says that it was only worth $22,000 at the moment of the accident. You still owe $36,000 – 6 x $1,000 = $30,000 on it (initial value minus the payments you have already done). The lienholder will ask you to provide the remaining $8,000. Here is where a GAP policy comes in handy — it will cover the $8,000.
Sounds like a good policy to have, doesn’t it? Well, not always.
Let’s assume that, instead of 36 months, you agreed to pay it off in 12 months. (For the sake of the example we are going to assume that you would still be paying $36,000 for it, i.e. $3,000 a month. This never happens in real life.) After six months you will have paid $18,000, leaving you with $18,000 to go. Given that the current market value of the car is of $22,000, as per the insurer’s evaluation, you are actually going to make a profit of $4,000. The GAP policy would be useless in this scenario.
You should consider buying a GAP policy when you know that the market value of the car will go down sooner than you will be paying it off. That’s easier to be said than done though, as nobody can foresee the future market trends and what a vehicle will be priced after a certain period of time. You can, however, use the Kelley Blue Book tool to get a ballpark figure on car rates and how their market value decreases in time.Admin