If your car is totaled or stolen and is deemed a total loss, your car insurance company will pay the value of your car, NOT what you owe on your loan. Because vehicles depreciate quickly, a total loss can result in negative equity. For example, if the value of your car is $25,000 but you owe $35,000, you would have $10,000 negative equity and be required to pay this back to the bank yourself.
GAP Insurance is one way to avoid this problem. It’s available at most dealerships when you purchase a vehicle. It covers the difference in the loan and the payment received from your insurance company. In the example above, GAP Insurance would cover the $10,000 negative equity.
When is it a good idea to buy GAP?
1. You’re rolling in negative equity from your trade-in vehicle
Let’s say the vehicle you’re trading in is worth $15,000 but you owe $20,000. You’d be rolling in $5,000 negative equity to the new loan. If the new vehicle is written off, you’ve already rolled in $5,000 more than it’s worth, so the chances of you receiving less than what you owe from the insurance company are very high. (note: make sure the gap insurance policy covers negative equity)
2. You’re financing with no cash down
Car loans typically use a simple-interest format, meaning that the interest you owe on the payment date is based on the principal owing that same day. This means at the beginning of the loan, most of your payment is going towards interest because the principal is higher. Once you’re a couple years into the loan, and the principal is lower, more of your payment will go towards what is owing.
3. You have financed for an extended term
Usually, vehicles will depreciate 20% in the first year, and then 10% each year following. If your loan is financed for 5 years or more, the vehicle will depreciate faster than the loan is paid off.
When to pass on GAP:
- You’re putting a large down payment towards the loan (20% or more)
- You have equity in your trade valuing 20% or more of the loan
- You’re financing for a short term (under 48 months)
If you have any questions about GAP or total loss, give us a call anytime at 1-855-829-8408!
