Understanding Gap Insurance in Canada

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What is GAP insurance?

If you are contemplating buying a new vehicle from a dealership, you will likely come across a salesperson trying to sell you a Gap Insurance policy. But what is gap insurance? GAP is an acronym for Guaranteed Asset Protection (or, in this case, Guaranteed Auto Protection). It is a car loan product that aims to protect new car owners from losing the total amount of their auto payment in the event of the car being damaged beyond repair — totaled. Gap insurance is an optional form of auto insurance in Canada and many car owners are unsure if they even have gap insurance (more on this later). 

Paying for a new car requires several steps. Most new car shoppers (between 80% and 90%) will require a car loan to finance their purchase. Factoring in a car loan, the next payment takes the form of a down payment. This is usually between 15% and 20% of the vehicle’s actual cash value. This downpayment coupled with a car loan covers the cost of the vehicle and leaves only the cost of the insurance. All told, buying a new vehicle is pretty pricey. Gap insurance aims to save you from paying even more money should your new car be involved in an accident that causes substantial so much damage that you cannot repair it.

What does GAP insurance cover?

Gap insurance is primarily there to compensate for depreciation. When a new vehicle is bought, it loses a substantial amount of its value as soon as you drive it out of the dealership because it is no longer “new.” The exact cost of depreciation varies from one model to another (as well as from one year to the next), but new vehicles usually lose between 25% and 40% of its cash value after purchase. This means that a new vehicle’s actual cash value might be $16000 on the day of purchase, but would drop to approximately $12000 the next day (down by 25%). Kind of a bummer, but it’s easy to overestimate the cost of that “NEW” sticker on the windshield. 

The reason depreciation is so important when considering gap insurance is precisely because of its effect on the cash value of your vehicle. Let’s carry on with this example vehicle: 

  • You purchase this $16,000 car with a 15% down payment of $2,400.
  • Next, you get a loan to finance the rest of the purchase to cover the gap, totaling $13,600. Congratulations! You are now the proud new owner of the vehicle. You drive it home. As soon as you leave the dealership car park, your new vehicle loses, let’s say, 25% of its value
  •  A week later, your brand new vehicle, now worth $12,000 is involved in an unfortunate car accident and is totaled. 
  • You make a call to your insurance company. They promise to write you a check for the estimated amount your car is worth prior to the accident. Because of the cost of depreciation, this check would be for $12,000. The thing is, you have paid $16,000 for your vehicle and your $13,600 loan is worth more than what your insurance company will give you. So, you still owe $1,600. This is what we call being “upside-down.” 
  • This is where you would need gap insurance to step it. Gap insurance would cover the “gap” between your insurance company’s payout and your outstanding loan amount to pay what you still owe. So that $1,600 is no skin off your chin because it’s covered by the lender. 

It’s useful to keep in mind that the benefit of gap insurance is proportional to the cost of the vehicle. Let’s say you go all out and splurge on your dream $40,000 car. You pay your $6,000 down payment (15%) and get a loan to cover the remaining $34,000. The next day, your vehicle’s actual cash value is down to $30000. If this vehicle was totaled, you would still owe $4000 on your car loan after your insurance company sent your check for $30,000. So, if you’re planning on shelling out a little more than you typically would on a vehicle, you might seriously consider the benefit of gap auto insurance.

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Is GAP insurance worth it?

The question of who might need gap insurance and benefit from this kind of auto insurance varies case by case. As should be clear by now, gap insurance is primarily a car loan product. If you buy a vehicle in cash, you will never be proposed gap insurance coverage. But, if you buy your vehicle from a dealership, you will likely be presented with the opportunity to buy gap insurance. But are all new cars worth the extra expense? Below are a few key points to consider when contemplating gap insurance. 

Are you “upside-down” on your car payments? In other words, is your car’s actual cash value less than the amount you owe on your car loan? As mentioned above, drivers who find themselves owing more than they would receive in an insurance payout are in the best place to benefit from gap insurance. Gap insurance makes sure you never have to pay back money on a new car you can no longer use even if you still owe your lender some money.

Did you pay for an overpriced car? This is somewhat connected to the above question. If you purchase a car that is priced at more than its worth (an easy mistake to make for newer drivers!), you will find yourself especially dissatisfied with your insurance company’s payout. For instance, if you paid $15000 for a used car being sold “as new,” your insurance company might decide its only worth $9000. This would leave you with a substantial gap between your insurance pay out and the amount you owe on a car loan. A good time to call in your gap insurance! 

Now that we have an idea of who might benefit most from gap insurance, let’s find out who should not spring for gap coverage. 

Is your car worth more than your outstanding loan amount? If your car is worth more than what you still owe, you have equity. Gap insurance would effectively do nothing in the event of an accident. 

Do you plan to refinance your vehicle? Refinancing a car simply means taking out a new loan to pay a pre-existing loan. Gap coverage does not carry from one loan plan to the next. So, if you plan on refinancing your vehicle soon after the initial purchase, there is no use in paying more for coverage that will not carry over. 

Note: Some institutions will let you cancel your gap coverage within a certain window (usually 30-60 days). So, if you are uncertain about whether or not your car is worth the extra expense of gap insurance, you can try it out for a short time!

How do I buy GAP insurance?

Now that we understand what gap insurance is, what is covers and who might be especially interested in purchasing it, let’s have a look at where you can buy this kind of coverage. You can purchase gap coverage from a variety of places. Loan institutions such as banks and credit unions and car dealerships all offer gap insurance. However, its good to keep in mind that car dealerships tend to be the most expensive places to purchase gap insurance. Credit unions are largely considered to have the best deals on gap insurance. 

Let’s talk cost — how much does gap insurance cost? Like all forms of insurance, it’s difficult to estimate an exact price. However, the good news is that gap insurance is one of the less expensive forms of insurance coverage to add to an insurance policy. Gap insurance usually costs between $250 and $400 dollars (although can cost up to $800). While the cost of gap insurance varies from one institution to the next, each provider’s price should be the same for all vehicles, whether you drive a truck or a smart car. 

One last thing to keep in mind is the payment method. You can choose to pay upfront for the total cost of the insurance, or you can roll it into the cost of you loan. This means that is you do end up requiring your gap insurance to pay for a car loan, the only cost you would be left with is that of the gap insurance policy itself.

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