What is Gap Insurance and do you need it?
Think about this: You just drove your brand new $40,000 vehicle off the lot at the dealership. When you head through an intersection, you get t-boned by a car that runs the red light. The car is a total write-off.
Your insurer confirms they will cover the full cost of the vehicle - $35,000. You tell them it’s worth $40,000. At the time of purchase, you paid $6,000 down and financed the remaining $34,000.
The carrier tells you it was worth $40,000 – until you drove it off the car park lot. (Typically, a vehicle’s value depreciates by at least 20 per cent as soon as you drove it off the dealer’s lot and by approximately 10 per cent each year after that.)
To make matters worse, the amount the insurance company said they would pay won’t cover your entire auto loan, meaning you have to pay the remaining $2,000.
This is where gap insurance comes in.
How it works
Gap insurance makes up the difference between what a person owes on a vehicle and that vehicle’s actual cash value if there’s an accident and it is declared a total loss. It pays out the difference between the actual value of the vehicle – which is usually covered by standard auto insurance policies – and the outstanding balance in the car loan.
Dealerships primarily offer gap insurance for new cars, but you might also be offered it if the car you’re buying is less than 3 years old, especially if it is a luxury vehicle. Many, but not all, leases include gap coverage.
Compared to other products dealerships offer – such as extended warranties that can cost several thousand dollars – it is relatively inexpensive. Ontario-based Driving.ca pegs the amount at around 5 per cent of the cost of collision and comprehensive coverage, which is between $350 and $800.
Prices vary depending on the length and amount of the car loan.
Coverage optional
Also called guaranteed asset protection insurance, or in the case of car policies, guaranteed auto protection, gap insurance is optional.
It is typically sold through car dealerships and financing companies, although there are also some insurance providers that offer this type of coverage. Most lenders and dealerships offer gap cover as a one-time premium, which can be rolled into the car loan.
This type of policy usually lasts for at most two years because, according to Driving.ca, by this time enough of the car loan has been paid back that there is no longer a gap between what is owed and the vehicle’s depreciated value.
When deciding whether to purchase gap insurance, there are several common exclusions that car buyers should keep in mind. These are:
- Car modifications not installed at the factory level, including stereo systems, speakers, and aesthetic upgrades
- Extended warranties
- Overdue payments and penalties
- Lease or trade-in expenses
For gap coverage to kick in, Canadian vehicle owners also need to purchase basic car coverage, otherwise, they will not be eligible for reimbursements.
Some good advice
Driving.ca has some good advice for car owners considering this type of coverage.
“Before you head over to the dealership to buy your new vehicle… contact your insurance company first and get a quote for gap insurance,” the firm wrote on its website. “That way, when you’re at the dealership and they ask you if you would like gap insurance rolled into your monthly vehicle payment, you’ll have a second quote to compare it to. Often, gap insurance purchased from an insurance company costs less than if it were purchased from a dealership.”
According to automotive website Edmunds, many Canadian car buyers find gap insurance appealing because “it protects them against two factors they can’t control – the quick depreciation of a new vehicle and the method insurance companies use to determine how much to pay if a car is totaled.”
Who needs it?
Not all drivers need it. Your need for it comes down to the details of your financing and risk tolerance. This type of coverage, however, does not suit all vehicle buyers. Gap insurance may make sense if:
- You have leased a new car
- You are buying a new car
- You are financing a vehicle for at least five years
- You have placed a small down payment (less than 25%) on the vehicle
- You did not make a down payment
- You have purchased a high-value vehicle that depreciates quickly
- You have rolled an old auto loan into a new one.
For those buying used cars, it is not worth taking out gap coverage as most of these vehicles do not depreciate as quickly as new ones and the loan terms are usually shorter.
Driving.ca also noted it’s unlikely that a dealership will offer someone gap insurance after they have already purchased a vehicle. In this situation, car owners’ best chance of getting coverage is through car insurance companies, although the process may take longer.
“You may have to make some calls before you find an insurance provider that is willing to offer it on a vehicle that has already been purchased,” the firm cautioned.
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