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You’re driving through an intersection when you get T-boned by another car. You’re fine, but your car is totaled. Since you’re still paying off this car, you may wonder: What happens to that loan? Will your car insurance cover the balance?
The answer is, it depends.
Your car insurance will only cover the current value of the car. If the balance on your car loan is larger than that, you will have to cover the difference out of pocket. That is, unless you’ve purchased a GAP waiver agreement when you financed the car. If you did, the full amount of the loan will be covered by this policy. Below we highlight what a GAP waiver is and what it covers.
GAP (Guaranteed Asset Protection) insurance is an optional add-on to your car loan contract that waives your obligation to pay the remaining balance on your auto loan in the event your car is totaled or stolen before you’re finished paying it off. GAP waivers are available for both new and used cars.
You can buy a GAP waiver when financing or refinancing a car , and the coverage can be paid in one lump sum or rolled into your auto loan. Once purchased, GAP will provide coverage for as long as your loan remains in place, provided you adhere to the terms of your loan contract.
Without a GAP waiver, insurance will only cover the car’s actual cash value (ACV), also known as its book value, in the event the car is totaled or stolen. You would then need to make up the difference between that amount and the loan balance.
A loan-to-value (LTV) ratio is the total value of your loan divided by the ACV of your car. You can use this formula to figure out the LTV ratio, expressed as a percentage:
Loan amount / car value x 100 = LTV
So, if you’re borrowing $30,000 to finance a car valued at $35,000, the LTV would be about 86%. If after a few years, you still have $20,000 left to pay on your loan and the car’s value dropped to $15,000, your LTV would be 133%, which means you owe more than the car is worth.
In this scenario, if your car got totaled or stolen, you would have to cover the gap between your loan balance ($20,000) and the car’s value ($15,000), or $5,000. If you had a GAP waiver, on the other hand, insurance would pay it.
Regardless of whether your car is damaged to the point that it is unusable or was stolen, a GAP waiver will cover the remaining balance on your car loan that your auto insurance policy won’t pay for. In some cases, GAP waivers will also cover the cost of your insurance deductible, up to a limit as defined by your contract.
GAP typically only kicks in when your car is damaged beyond repair or has been stolen, and it only covers what you owe on the car. This means GAP won’t cover other people or their property. It also means it won’t foot medical bills or legal costs related to an accident.
Other costs GAP typically doesn’t cover include:
GAP waivers are typically not required when financing the purchase of a car (leasing companies may require them), but here are seven scenarios where it may be worthwhile to purchase optional GAP waiver coverage:
If you have an upside-down auto loan , which means the amount you owe is more than the cash value of your car, then it may be a good idea to add a GAP waiver. If you were to total a car with an upside-down loan (or it got stolen), you would end up owing more to the lender than the insurance would pay out (which would max out at the car’s current value).
Your down payment size matters when financing the purchase of a new or used car. The more money you put down on a car, the lower your LTV ratio, and the lower the chance you’ll ever owe more than your car is worth. If you put down less than 20% on a new car purchase, however, it might be worth getting a GAP waiver. Depreciation starts as soon as you drive the car off the lot, and having a high loan balance exposes you to out-of-pocket costs in the event your car is stolen or totaled.
If you put a lot of miles on your car, it will depreciate faster. That means if your car became unusable at some point, its value could be lower than the amount you owe on the loan. This could expose you to costs in the event that it gets totaled or stolen.
Luxury cars often depreciate faster than non-luxury cars. Before financing your car, and before making a decision about a GAP waiver, you might want to research the make and model of the car and how quickly you can expect it to depreciate. If the value will decline quickly, a GAP agreement could be a good thing to have in your back pocket.
When you take out a car loan, you typically pay more toward interest in the beginning of your loan amortization schedule. Having a higher-than-average interest rate on your car loan can affect how quickly you build equity over time. If the car gets totaled or stolen before you’ve had a chance to build much equity, you would likely owe more on the loan than the value of the car.
A long-term car loan creates a problem similar to having a high interest loan. The longer the loan term, the longer it will take you to build up equity. This leaves you vulnerable to a period of time during which your loan balance may be higher than the value of the car.
Some creditors require you to obtain GAP coverage when you lease a car. A GAP waiver (or something similar called loan/lease coverage) may be part of the agreement when you lease a vehicle. Should your car get totaled or stolen, and you need to terminate your lease early, it will cover the “gap” between the early termination payoff and the value of the car.
A GAP waiver and GAP insurance offer the same type of coverage. The only difference is where and when the policy is purchased.
A GAP waiver is an add-on that’s offered by your lender or finance company when you take out a loan on the car or when you refinance it. GAP insurance, on the other hand, is an outside product that's available through a licensed insurance agent or broker and can be purchased at any time, even if you’re using a loan to buy a car from a private seller .
Driving with GAP coverage typically isn’t necessary when financing a car purchase, but it can provide some peace of mind. If your car gets totaled or stolen, you won’t get hit with having to pay off a major part of your loan.
Your existing auto policy typically only covers the cash value of your car. Because of depreciation, there’s a chance that your coverage won’t be enough to pay for the full amount of the loan, particularly during the early months or years of your loan, when you haven’t built up much equity in your car.
A GAP waiver is typically offered as an additional option to your loan when you are buying or refinancing a car. You generally have the option of paying for it upfront in one lump sum or having it folded into the loan. You’ll sign the waiver at the same time as you sign the rest of your loan documents.
When you purchase a GAP waiver, you may receive a GAP waiver agreement that spells out all the terms and conditions of the coverage, including the GAP refund policy if one exists.
In general, a GAP waiver may only be purchased at the time you are taking out a new loan or refinancing an existing loan; you can’t add it on later. You can, however, purchase GAP insurance from a third-party company at a later date, as long as the loan has not been fully paid off.
If you purchase a GAP waiver from a lender or financing company at the time of financing or refinancing, the average cost is typically $400 to $700. While it may be hard to come up with that full amount all at once, if you fold this cost into your loan amount, you may pay interest on the cost of the waiver. Purchasing GAP insurance separately from a third-party insurance company tends to cost less. You may be able to get GAP insurance for $20 to $40 per year if you bundle it into your existing auto insurance policy.
Unless GAP was required by your creditor (such as in the case of a lease), you can typically cancel it at any time. And you may be entitled to have all or some of the cost refunded. It all depends on what’s in your contract, how soon you ask for a refund, and how you paid.
You may be able to get a full refund if you cancel within a certain period of time (such as 30 or 60 days). If it’s later than that, and you paid in full upfront, you may be able to receive a prorated amount back. If you rolled the cost of the waiver into your loan amount, it will likely be harder to get a refund.
Because the GAP waiver is tied to your original loan, it won’t carry over to your new loan when you refinance your car. However, you may be able to get a refund of some of the cost of the waiver. In addition, you can purchase a GAP waiver for your new loan through your new lender.
There are pros and cons of auto loan refinancing . You may pay more interest over the life of the loan if you refinance with an extended term. Refinancing for a lower interest rate without extending your term can lower your total borrowing costs over the life of your loan.
GAP coverage can make sense in any situation where your loan balance is likely to be larger than your car’s actual cash value, such as when you’re starting out upside-down on a car loan, you have a high interest rate, you put little down on the car, or you put a lot of miles on your car.
If you’re interested in researching your auto loan refinancing options, Lantern by SoFi can help. Just fill out one simple form to compare auto refinance rates in our marketplace.
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