Is Gap Insurance a Scam? Understanding This Controversial Car Insurance Add-On

Recently I had not one, but two new cars stolen right from my driveway. (Yes, I do live near St. Louis. Why do you ask?).

In both cases, I had financed the cars. And I had negative equity in both cars. That’s finance-speak for “I owed more on the cars than they were worth. ” That is, I was “upside down” on the cars.

This happens a lot. I finance the cars I buy and sell all the time because I’d rather use my money to build Select Insurance Group than to buy a car.

I would have lost $20,000 to $30,000 without the gap insurance I signed up for. I would have had to repay both loans. AND replace those two cars, somehow!.

But if you used a loan to buy the car, you and the lender may have more at stake than just the car. You still have to pay back the loan, even if the car is totaled!

So you need some additional kind of coverage that protects the loan, not the car itself.

Gap insurance is one of the most debated add-ons in the car insurance industry. While some financiers and dealers present it as an essential protection, others claim it’s an expensive scam.

So what’s the truth? Is gap insurance worth it or should you avoid it at all costs?

In this comprehensive guide, we’ll cut through the confusion, explain how gap coverage works discuss the pros and cons and offer tips for getting the right protection. Read on to finally understand if gap insurance is right for you.

What is Gap Insurance?

Also known as GAP insurance, gap coverage is an add-on policy that fills the gap between what your car is worth and what you owe on your auto loan if the vehicle is totaled or stolen.

For example, say you buy a new $30,000 car and finance it over 5 years. After just one year, you get into an accident and the car is totaled. Your standard auto insurance policy pays out the current value of your car, around $22,000 for a 1-year old model. But you still owe $27,000 on your loan, leaving a $5,000 gap you have to pay out-of-pocket.

Gap insurance steps in to cover this difference so you don’t have to. It pays the remaining loan balance after your regular insurance settles its portion. This prevents you from being “upside down” on your loan for a car you no longer have.

The Case Against Gap Insurance

Now that you understand how gap coverage works, let’s examine some of the common arguments that it’s an unnecessary expense and even a scam in some cases:

You’re Already Paying for Depreciation

Your existing car insurance factors in depreciation. You’re already paying a lower premium because the insurer is estimating lower payouts as the car loses value over time. Having to pay extra for gap insurance seems unfair.

Loans Cover the Gap

Most auto loans include a “gap waiver” stating the lender assumes the loss if insurance doesn’t fully pay off the loan. So gap insurance is redundant.

It’s Pure Profit for Lenders

Banks and dealers make huge profits on overpriced gap insurance, paying claims out of a fraction of the premiums. It’s a cash cow sold through misleading fear tactics.

Claims Are Rare

Total losses only occur in a small percentage of accidents. Paying extra for gap insurance to cover a rare event is not financially smart. It’s cheaper to just cover the gap yourself in the unlikely event of a total loss.

You Can Negotiate the Gap

Instead of gap insurance, negotiate to have the dealer or lender reduce or waive the gap amount in your loan contract. Then you aren’t paying extra for unnecessary protection.

Extended Warranties are Better

Rather than gap coverage, put your money towards an extended repair warranty. That way your car gets fixed and you avoid having to replace it and buy expensive gap insurance.

The Case For Gap Insurance

On the other hand, there are also strong arguments in favor of gap coverage:

Depreciation is Steep

New cars lose up to 40% of their value in the first year. Even with accounted depreciation, insurance won’t pay off what you owe without gap coverage.

Loans Have Limits

Lender gap waivers have upper limits, exclusions, and time limits that reduce their usefulness. They may not fully protect you.

It’s Affordable Protection

When priced fairly, gap insurance only costs $10-$15 per month which is affordable peace of mind against a huge expense.

Claims Happen

While less common on newer cars, total losses do happen. It’s devastating to still owe thousands on a car you no longer have. Gap insurance provides financial security.

You Should Focus on Prevention

Rather than extended warranties, put funds into preventative maintenance. Well-maintained cars are less likely to get totaled in the first place.

The Market is Tricky

Trying to negotiate your loan balance in this volatile market is difficult. Lenders hold the leverage. Gap insurance guarantees protection.

As you can see, there are compelling cases both for and against gap coverage. There’s no definitively right or wrong answer here. So what should you do?

Should You Buy Gap Insurance? Key Tips

Here are some guidelines on whether gap insurance makes sense for you and how to get the best policy if you choose to buy it:

Only consider it if buying a new or near-new car – depreciation declines over time so the gap shrinks.
Compare gap costs from your insurer vs. the dealer – dealers charge 2-4 times more. Go with your carrier.
If financing over 60 months, strongly consider gap insurance due to steep depreciation.
Read your loan terms carefully to understand if and how the lender covers you. Don’t duplicate coverage.
See if you can extend your regular car insurance settlement period from 30 to 60-90 days to account for depreciation.
Negotiate the waiver or reduction of gap amounts in your loan agreement whenever possible.
Buy just enough gap insurance to cover potential depreciation, not your entire loan balance.
Cancel the policy once you’re closer to breaking even on the loan balance vs. car value – usually after 2-3 years.

The Bottom Line on Gap Insurance

At the end of the day, gap insurance usually makes sense for cars and loans with the highest depreciation risk. Done right, it can give you peace of mind after an accident without paying exorbitant premiums long-term.

To avoid overpaying or being misled, always compare quotes from your insurer before even considering the dealer’s overpriced offerings. And negotiate your financing terms to minimize or eliminate the gap you have to cover.

Gap insurance does fill a legitimate need for certain buyers and situations. Just approach cautiously, only purchase as much coverage as you truly require, and shop around for the best rates. It can provide affordable protection against financial loss – as long as you avoid the inflated prices some providers try to charge.

How to do it

So here’s how to do it:

Once you’ve chosen a car and agreed on its features and price, but before you go to the finance desk to sign the loan papers, excuse yourself and say you need to call your insurance company to make sure the car is covered. The finance company will require proof of insurance anyway, at signing, so this is perfectly natural.

Then you call us and one of my highly trained and experienced agents will get you a bunch of quotes from the best insurance companies in your state, WITH THE GAP insurance. It’ll be a reasonable monthly amount. Not hundreds or thousands of dollars, unless you’re financing a supercar or exotic.

After that, when you go to the finance office, they’ll give you a big, long piece of paper with all the “back-end” products written on it. Do you get it?

Since you already have gap coverage and can show proof of it, all you have to do is take the pen and cross out the gap insurance premium on their sheet.

Give it back to the finance manager with a smile and tell him you already have gap insurance through your insurance company. Then ask them to fill out the paperwork again without the gap insurance.

Even better, you will have the finance manager and dealer manager cursing you under their breath.

Which is a great feeling!

See you on the road!

Steve “Mr. Insurance” Ludwig

How Gap Insurance Works

In the event that you total your car but still owe more on it than it’s worth, your car insurance will pay up to the car’s actual cash value (less your deductible) and your gap insurance will pay off the rest of your loan.

So you can walk away clean, except for the deductible you chose.

You may need gap insurance if you can’t just write a check and leave your wrecked car without blinking. (If you can do so, you probably wouldn’t be financing!).

But here’s what you should know about gap insurance:

The people at the car dealership’s finance desk aren’t giving it to you because they want to. They’re looking to make money!.

Truly, I tell you, consumers have more damage to their property at the F

Gap insurance at a dealership is a massively marked-up product. The dealership buys the coverage wholesale, and sells it to you at whatever they think you’ll fall for. It can be a 300%, 400% or 500% markup. They get a check for it up front, in a few days, from the gap insurance company.

A lot of the time, they’ll get you to finance the purchase, which means the finance company pays them again.

And you pay that much more in interest over the life of the loan.

Now, here’s the trap:

When you finance Gap insurance, you’ll have to pay interest on the premium for as long as you have the loan. This means that you won’t just pay interest while you’re upside down in the car (which could be for only two or three years, depending on the car and how much you put down), but for the whole loan term!

Also, it’s likely that they’ll sneak in gap premiums that last the life of the loan as well. Not just for the two or three years you’ll probably be upside down.

You can always count on the I-desk and the gap insurance company they choose to write the loan terms and policy so that they benefit the most, not you.

When you’re not upside down in your car, it doesn’t make sense to pay interest or premiums on gap insurance.

But once they lure you into paying a single, up-front gap insurance premium by financing it, you’re stuck!

There’s no graceful way to undo it. The finance company has already written the check to the dealership.

In theory, you could pay off or refinance the loan within a month. But the entire premium is already baked into the loan you’re paying off.

But if you’re financing the car, the finance company might require gap insurance.

I’ll tell you “what then!” Then you call us! That’s “what then!”

See, the finance company just wants to hedge the risk. They want the gap insurance because that’s part of the loan that’s unsecured. That is, that’s part of the loan they don’t have collateral for!.

But they don’t care where you get it from!

And lots of car insurance companies would love to sell you gap insurance themselves – at a fraction of the cost you’d pay buying it from the dealer.

Meanwhile, there are other major advantages, too:

You are still in charge when you buy gap from someone other than the dealership, like your own car insurance company.

You’re not paying interest on the loan you took out to pay for gap insurance.
As soon as you’re not upside down, you can cancel the Gap coverage.
The gap insurance can be “turned on” or “turned off” whenever you want. Don’t plan to drive the car this winter? You can lower or get rid of the gap coverage. Or, make it only apply to collision and not whole-car.

Here’s why you shouldn’t take gap insurance on your car

FAQ

Is gap insurance actually worth it?

However, gap insurance makes sense when your auto loan balance is likely to exceed the actual value of the car. This usually happens when: You put little or no money down when you financed your car. Your trade-in vehicle was less than what you owed on that loan, and that amount was added to your new car loan.

Is Gap a waste of money?

If your vehicle is not financed, there is no reason to purchase gap coverage. If you do finance your vehicle, gap coverage can be a good idea, but it depends on how much you drive and how quickly your car depreciates. Keep in mind that cars can depreciate rapidly.

What are the cons of gap insurance?

The cons of gap insurance are that you may end up overpaying for coverage or paying for unnecessary coverage, particularly if you buy it through a lender or dealership. In most cases, gap coverage isn’t worthwhile for older cars. Some high-priced luxury and sports cars may not be eligible.

Why didn’t my gap insurance pay?

There are a few reasons your gap insurance policy won’t pay: The policy lapsed for nonpayment before the date of the total loss. Fraud or misrepresentation. The claim isn’t covered by the policy.

Is GAP insurance worth it?

Many things will determine if gap insurance is worth it for you, including the cost, coverage options, available providers, whether you qualify, and other factors. Although fairly inexpensive, gap insurance is a particular type of coverage used only when a new vehicle you’ve financed is totaled or stolen. So is gap insurance the right choice?

What does GAP insurance cover?

Gap insurance covers what’s owed on a car after a total loss, whether that’s the result of an accident or vehicle theft. Gap insurance pays out after comprehensive and collision coverage, two coverage types that are typically required when you buy or lease a new vehicle.

How do I purchase GAP insurance?

There are several ways you can purchase gap insurance. According to NerdWallet, you can purchase your gap insurance through your insurance provider as an add-on coverage, through an insurance company that provides gap insurance for a one-time fee only, or your dealership or lender may provide gap insurance through your loan payments.

Do I need GAP insurance if I owe more?

Yes, it is good to have gap insurance if you owe more on your car loan or lease than your car is worth. Gap insurance is especially useful if you’ve made a small down payment on your vehicle, you have a long-term loan (more than 4 years), or you have a car that depreciates in value quickly.