You've heard the ads on the radio, "Buy a certified pre-owned luxury auto for almost half of what it cost new." Have you ever wondered how a relatively new model could be worth half the original purchase price after just a couple of years?
Virtually every car depreciates, and that depreciation is not linear. After three years, most cars are worth 45%-53% of what they cost new. In the first year, 25%-35% depreciation is common, but some cars may drop by 50%-60% in the first year. Fluctuations in gas prices, ceased production of a make or model, and quality concerns can drive depreciation rates even higher.
Why the GAP?
If you have a loan on your car, your payments may not keep up with depreciation for a few years. This can create a difference between what your car is worth and what you still owe on your auto loan. Say you take out an auto loan for $25,000 in March of 2010, at 6.5% APR for 60 months. In March of 2011, you would still owe $20,626 on that car.
The actual cash value (ACV) of the car might be roughly $17,500--reflecting 30% depreciation. If the car were stolen and not recovered, or totaled in an accident, you would receive the ACV from your insurance company. You could find yourself owing about $3,000 more than the settlement from your auto insurance company.
You may be able to protect yourself from such financial calamity by purchasing Guaranteed Auto Protection (GAP) insurance. In the event of a total loss, GAP coverage pays the difference between what you owe on your auto loan, or lease contract, and the insurance settlement. GAP coverage is available from many sources, including car dealerships, auto insurance companies, and other third-party providers. Premiums vary widely, and can be very low.
Beware of Negative Equity Exclusions
When shopping for GAP coverage, make sure the terms of the policy indicate that the insurer will pay off your entire loan balance.
For example, if you purchase a new car with a trade-in that has negative equity (the trade value is less than what you owe on your auto loan), that negative equity can be rolled into your new car loan. Some GAP policies do not cover negative equity balances, and are only willing to pay for the depreciation on new cars. If you suffered a total loss on your new car, you could find yourself responsible for a sizeable amount of money--even with GAP protection in place.
When shopping for GAP insurance, keep the following in mind:
The best way to get started is to fill out the easy quote form at the top of the page. Many auto insurers offer GAP coverage at very affordable rates.
Ryan Hurlbert lives and works in the Pacific Northwest. As an insurance agent, he produced and presented educational seminars on various topics from insurance basics to strategies for dealing with teen drivers. He has researched and produced marketing materials in the insurance, auto, and financial industries. Ryan majored in business and received his Bachelor of Science degree from Portland State University.
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