I recently purchased a car and was presented some “upgrade options” in the finance office. One of these add-on’s was the option to purchase something known as Gap Insurance. When faced with the question of “Should I buy gap insurance”, I now decline.
What is it?
Gap Insurance is basically an insurance policy for the loan you are taking out to finance a vehicle purchase. As your car ages, its value decreases. As you pay off your loan, its balance decreases. And, we all know which one goes down faster, right? 🙂
If you are in an accident, and your car gets totaled, the insurance pays out a lump sum to cover the losses. If you owe more on the loan that what the payout amount is, you have a “gap” and making up the difference to pay off the loan will be 100% your responsibility. Gap Insurance will pay this difference for you (minus your insurance deductible).
You can read a more detailed explanation here: https://www.iii.org/article/what-gap-insurance
Why?
The price of vehicles today makes it more and more necessary and/or attractive to take out loans for longer durations than ever before. 30 years ago, a 60 month loan was pretty much the longest loan any lender would offer. Today, we have options of 66, 72, 75, 84… And, the longer that loan is set up for, the longer it takes to not only pay it off, but just to get to a point where the loan balance dips below the actual value of the vehicle.
Let’s say you buy a $20,000 vehicle and put 10% down. By the time you’ve added in sales tax, dealer fees, and whatever else… we will assume you’re back to the same $20,000 amount for financing purposes.
Let’s say that you take a 60 month loan at 3% for that vehicle. This means that you have a $360/month payment. After three full years of payments, your outstanding loan balance is about $8200 and we’ll just generically assume that that’s what your vehicle is now also worth.
When does this come up?
When you’re sitting with the finance person to sign the loan, they offer you Gap Insurance at a cost of $650 (this number is almost certainly low, but it will demonstrate my point nicely). If you add that into your loan, your loan is now $20,650. Your monthly payment is more like $371 and your loan balance at the end of three years is roughly $8400.
All in all, that doesn’t seem so horrible, does it? But here’s the rub… You’ve already paid for gap insurance which has been rolled into the loan. And you’re paying finance charges on that 650 as well. So, your total cost for that insurance coverage is roughly around $725. You have no way to get out of it except to pay the loan off early or request a refund on the unused principle from the dealership where you bought the car. And, by the third year, paying cancelation fees will result in you effectively getting nothing back.
Other options?
Conversely, if you add Gap Insurance (sometimes offered as “Loan Payoff” or similar), you will pay about $3-$4 per month. And you can cancel it whenever you want. Over the course of the full five year loan (and you don’t need it once the value of the car is equal to or greater than the balance on the loan), you would spend about $180-$200 for the exact same coverage that the dealerships offered you at a price that was anywhere from 3x to 6x the cost.
Conclusion – Should I buy it?
When you finance a vehicle purchase, you will almost always be faced with the question of “Should I buy gap insurance”? For new vehicles, I fully believe that you should carry it. Should you fold it into the loan when the dealer offers it? Absolutely not. Dealerships are paid for this because they are actively selling it to you. And for their efforts, the lender pays them a “rebate” (like a commission).
If you have car insurance through an “agentless” company, no one is actively selling it to you. Many agents will gloss over it as well. But it is almost certainly available through your insurance. So, consider adding it there and removing it when your loan balance is less than the value of the car.
Think twice before you add ANY of the things that someone in the finance office offers you. They are making money for the dealership, NOT protecting you.
What will be your answer the next time you ask yourself “Should I buy gap insurance”? Leave your comments below!