When you finance a vehicle, you finance the vehicle, sales tax, licensing, and documentation fees. That adds up to about 110% of the selling price. With an average down payment of 20%, you are barely covering more than the sales tax and other applicable fees.
For the ease of math, let’s go ahead and use this example:
Selling price $22,000
Sales tax and other fees $2,200
Down payment $4,000
Total financed $20,200
The interest in automotive loans are front-loaded. Finance companies want their interest first, since that’s the part that makes them money. Essentially, the monthly payments for the first year or two are mostly interest. Compound that with depreciation during that period, you might be looking at a perfect storm. After 2 years of ownership with a typical monthly payment of $400 (for 60 months), and 40% depreciation from the above example vehicle, you have the following:
Payoff amount $16,500
Market value $13,200
Net difference $3,300
In any case that your vehicle is declared a total loss by your insurance company, they will give you the market value. Whether it’d be a stolen vehicle, natural disaster, or an accident, there will be a point where the damage to your vehicle will be more than the cost of the repair. If so, you might be responsible for the net difference between the payoff amount and what the insurance company gives you. Actually, you’re responsible for that difference plus your insurance deductible.
The scenario becomes worse if your finance terms are longer than 60 months, your down payment is less than the example 20%, ownership of the vehicle is less than the example 2 years, depreciation is more than the stated 40%, or you are carrying negative equity from your trade-in.
Get the gap insurance if you:
- carry negative equity from trade-in
- have less than 40% down payment
- plan to finance longer than 48 months
- are purchasing high depreciation vehicle (high-end luxury models, domestic makes, third-tier imports, etc…)
- live in high crime rate and/or natural disaster area
- are purchasing for your teenage drivers
Of course, there are always rip-off’s. If the dealership charges you more than $600-700 for this service, then pass on it. You can get it with your own insurance carrier, but the only catch with that is you still have to pay your insurance deductible.