Credit 201: “GAP Policy; Do I Need It? Maybe.”

*** Disclaimer: This article, along with all of my articles, is a work of personal opinion. I make no promise as to the outcome of your choice to purchase or not purchase a GAP policy. ***

Anyone that tells me they “always get GAP” or “never get GAP” has made a foolish error. The decision of whether to get a GAP policy or not get a GAP policy is one that should be made completely based on the actual numbers, NOT opinions or preferences. I’ll walk you through what GAP is, how to tell whether you need it or not, and how to make sure you don’t pay too much for it.

“What is GAP?”

GAP or “Guaranteed Asset Protection” is a small insurance policy that many individuals get at the time they finance a vehicle or piece of movable property such as Boats, Recreational Vehicles, and Motorcycles. The job of the GAP policy is to step in, in the event of a Total Loss Accident and pays all or a large portion of whatever Negative Equity still remains on your auto loan.

Negative Equity: The Upside Down effect resulting from the rapid depreciation of a piece of collateral in comparison with the balance of the loan itself.

Total Loss Accident: An accident in which the collateral is deemed to be damaged irreparably, or at least so severely that it would not be able to be easily brought back to a safe working condition.

What I’m getting at, is that along with the mileage you put on your vehicle, as well as the loss you take when your New Truck becomes yours and is therefore a ‘Used’ Truck, comes DEPRECIATION. With that depreciation, comes the very real fact that an accident may happen, and if it does happen you’ll want to rest assured that the entire loan balance you owe gets paid off. How crummy would it be if you were still paying a car note on a car that got totaled out 11 months ago!?

Depreciation: The loss of value a piece of collateral has over time for a number of reasons, including but not entirely limited to wear, tear, and mileage.

“What’s LTV?

LTV or “Loan-to-Value” is the ratio that tells lenders how Upside-Down you are on your collateralized loan. For example, home loan lenders nearly always ask for their loans to be in a Positive Equity position; meaning the borrower is right-side-up at the time of purchase because of a down payment. Auto Loan Lenders however, have guidelines in place that are individual to the Type & Age of Collateral as well as the Credit Tier of the Applicant.

Click here to read my other post all about LTV

The industry standard for finding the value of a movable vehicle as of right now is with the old yellow book (www.NADAguides.com). Simply search the car, motorcycle, or even a boat, by the Year, Make, Model, Trim Level, Mileage, and Notable Features and you’ll come up with a breakdown of its values. For a Used Vehicle, the “Clean Trade-In” is the true worth and therefore the amount you are likely to receive in the event of an accident. For New Vehicles, however, the “Invoice” value is viewed as the base worth (average retail is a decent number to base a boat or RV’s value upon).
Seriously though, if you still need more clarification.. read my other article on LTV

The purpose of lenders approving higher LTV’s for individuals with better credit is to allow you, the customer, to come up with less cash down in order to cover the inherent cost of taxes as well as the added cost of adding back-end products like GAP and warranties. Typically, the higher a person’s credit, the more upside-down is acceptable. This goes back to when I told you in Credit 101: How to Get Approved that “Lending is all about risk”. Someone with better credit is less risky and therefore more likely to payoff any deficiency on their loan should their insurance not payoff the entirety of their loan.

≥95% LTV

“Let’s get to the point! Do I need it?”

Consider your drive to work, and your usual habits of driving to see family, get groceries, or just to get the 8 month old in the backseat to fall asleep in his car seat before you make it home. What type of job do you have? Do you park your car and take the work van? Do you drive 25+ minutes through traffic to get there in the morning? Along with that, consider how much your LTV became after you rolled in TTL, that extended warranty, after you applied $1500 in rebates and put $1,000 more down in cash. Where did the numbers land?

As much as I love rules of thumb that you can live by… they don’t always fully encompass the vast array of factors you have to look at to make a wise decision. In regards to GAP though and how much upside-down is enough to warrant getting a GAP policy; I typically recommend to my customers that they at least do some thinking about it when their LTV at the time of purchase is anything 95% or more.

More months may mean a smaller payment, but it also means less money going towards the principal balance you owe, resulting in your loan decreasing slower than the value of your vehicle.

I know what you’re thinking — 95%, isn’t that right-side-up by 5%? You are correct, but for many of my customers the driving they do is enough to put then upside-down within a matter of 6 months after their initial purchase. That, combined with the fact that most folks these days are financing their auto loans longer and longer (I’d say 72 months on average but often times longer) equates to a whole bunch of negative equity.

REALTORs, DELIVERY DRIVERs, and OUTSIDE SALES REPS

I have a lot of customers that are drivers for Uber, Lyft, and Waitr. These and other self contracted driving jobs add thousands of extra miles to the worker’s vehicle each year. Also, I work with many realtors and outside salespeople that use their own personal vehicles to go from one client meeting to the next all day, everyday. Although, at year end there are certain amounts of tax deductions they can claim; those credits are frequently outweighed by the loss in value as well as wear and tear they’ve put on their vehicle. The unsuspecting part is that most people in this line of work don’t realize the added cost until it comes time for refinance or trade in.

Myth: “If I get GAP coverage, my entire auto loan will get paid in full if I wreck”

EXAMPLES of GAP in Action:

Okay, let’s say your payoff was about $32,970 at the time of your total loss accident. Let’s also throw in that your LTV at the time was 127%. From there we can calculate and figure out that your vehicle was only truly worth $25,960. So then your insurance will more than likely swoop in and generously payoff about $26,000 of your $32,970 loan balance. Each day you are still accruing interest on your loan and still have a balance left owed of around $7,000. You can’t trade in a totaled out vehicle. So without GAP you’d be forced to either keep making auto loan payments or payoff the remaining balance in full. #Tragic

Instead, if you had GAP on the auto loan the remaining $7k would get eaten up by the policy, so you would then be free to start shopping for another vehicle without the looming balance of the last one still hanging over your head. It’s important to note here that each GAP Policy provider may have different over costs but also may have different LTV maximums that they are comfortable paying out. For instance, in our example, if the you had GAP on this loan but the GAP company set their Max LTV at 125% then you would still be responsible for paying off the 2% (≈$520) out of pocket. Which, I must say is a heck of a lot better than $7,000.

*** Remember that if you purchased a warranty at the time you bought your vehicle, you can get usually get a refund or a least a portion back to help you cover the left over balance after you get in total loss accident. ***

“How to buy it at the right price/time/way?”

There are 2 routes to go when trying to purchase a GAP Policy. You can either get a month to month policy (typically these types of policies are sold by your own automotive insurance agency for a specific amount per month); the other is to buy it from a 3rd party. BEWARE: the majority of folks purchase their GAP policies directly from the dealership but this is just another area where dealerships make a huge profit off of us little guys. Instead, you can call your local Credit Union and have them price it without all of the ridiculous amount of mark-up — that also goes for extended warranties. I see guys paying double what they should for top of the line, schmancy “platinum level” warranties all of the time only to turn around and price it for them through the credit union for many hundreds less for equal or better terms.

GAP Policies, along with all other back-end products sold in the finance offices of dealerships are like many things today, subject to helacious mark-up. However, the dealerships are not the only ones who offer GAP Policies. Credit Unions, Banks, and Insurance Agencies all sell GAP as well. In fact you may find that, depending on the circumstances, shopping around for GAP pricing ahead of time may save you hundreds when it comes time to actually finance your ride.

***UPDATED: There is actually a 3rd option which can be the least expensive of all 3. Some Auto Insurance companies offer GAP as a rider which is just tacked on the back of your existing insurance premium. This is less costly by far because unlike the other 2 types I have described below, the rider is not added to the principal of your auto loan, saving you untold $ in interest as well. Imaging paying an extra $12/month on insurance, and it only taking you 2 years to get right-side-up… Well if you cancel the GAP rider at that time your only expense was the $288 you paid into it.

• Where Can I Get It?
  • Most dealerships will try to convince you that if you don’t get it through them that you’ll have to come up out of pocket later, which is sometimes true but not always.
  • Some insurance companies sell GAP contracts that have a month to month cost like any other subscription service nowadays.
  • Banks and Credit Unions sell GAP at a lower cost most times
• When Can I Get It?
  • Usually you will need to purchase it at the same time as you finance your vehicle but not always. For instance, even if I was buying a car from a dealership my Credit Union can still sell me a GAP policy before my loan hits their books. Their’s is about $300 cheaper than what the dealerships in the area offer.
• Which Gap is Right For Me?
  • First, ask yourself what your LTV at time of purchase is and whether the GAP contract you are thinking of getting will cover that LTV. If you are going to be financing a car at 135% LTV but the Max LTV payout is on up to 125% well, Houston, we have a problem.
  • Secondly, if you consider going with a subscription-style price model, like a policy from your regular auto insurance agent that costs $6 monthly, and although you financed 48 months you plan to trade in after 24 months… Well then your $6 monthly investment will have only costed you $144. Whereas, if you bought that $795 policy from Dealer Dan, yeah you could ask for a prorate or partial refund when it comes time for the trade in, but don’t expect a fairly large amount back after having gone 2 years into the loan.

In conclusion, do you need to get a GAP policy when you finance a car? Sometimes you do, sometimes you don’t, but don’t let opinion or feelings be the determining factor. Instead, let the numbers do the weighing and start thinking about the numbers long before you decide to head on down to the dealership lot.

Your friendly neighborhood banker,

Josh Romine