To Gap or not to Gap

So you are at the auto dealer and finally have got your car purchase deal all set. Suddenly, in bursts the finance manager with a life altering question: “What if your car gets involved in an accident?” Technically speaking, the lienholder or leaseholder still owns the car, but you still have to replace it, and if there is a loan balance, you must still pay for it…even after your auto insurance company (that’s me) pays off all the property damages from a total loss. Thank goodness the finance manager was there to introduce you to wait for it…wait for it…GAP Insurance.

Gap Insurance, covers some things that traditional auto insurance does not. Basically, it closes the gap between what an insurer pays if the car is totaled or stolen and what you owe the finance company.

So here is the math of it:

Assume you purchased an auto three months ago for $25,000 and begin paying at $500 a month based on an interest rate of 6% (somewhat high I know, but the math is easier for me). Then, disaster hits: a U.S. satellite falls from orbit and crashes on your parked unoccupied vehicle and destroys it.

The car insurance company then asks the actuaries in an ivory tower to decide what your vehicle is worth. They determine that your vehicle was worth only $20,000 at the time of this incident. Your auto is only three months old and it has already lost 20% of its original value. To make matters worse, the finance company requires you to pay in full, the amount you owe them. Computing tax, interest, and license fees, the finance company figures that you owe them $28,000.

And there you have it. An $8,000 “gap” between the $20,000 the insurance company will pay and the $28,000 demanded by the finance company. Most people with this deal will be up a creek, but not if you have gap insurance.

So do you always need gap insurance? It largely depends whether you put money down and length of loan term.. If your regular car insurance policy will pay off the financed amount in full because you put a lump sum down at closing and therefore have equity or are breakeven in your loan terms, it may be a good idea not to get a gap policy.

Any questions?