Gap insurance is a term that drops into vehicle-lease discussions like a cluster bomb of confusion. Suddenly, what seemed straightforward is a jumble of obscure insurance-company terms and a haze of incomprehensible numbers.
Let’s straighten it out — methodically, and in digestible chunks.
Gap insurance is simple protection from being stuck owing more on a wrecked or stolen car than it’s worth. It’s no more complex than that. If you’re thinking of buying a car, make sure you’re getting a good deal by comparing it with what’s available at AutoGravity.
There’s a very good chance that gap insurance is already an element of your existing comprehensive auto-insurance policy. Ask your insurer before purchasing a policy from the vehicle dealer.
The moment a new vehicle is bought or leased and drives off a dealership lot, it begins to lose value. Often that drop-off is so precipitous that, the lessee will owe more in lease payments than the vehicle is worth. It’s this balance — really an imbalance — that gap insurance covers.
In the case of a total loss, typical comprehensive insurance policies pay off on the basis of the depreciated value of a vehicle. The difference between what is owed and the depreciated payout? That’s the gap.
Jump to one of the sections below:
- Do You Need Gap Insurance?
- What Is Comprehensive Insurance?
- What Is Liability?
- Elements of a Lease – All Lease Terms Explained
- What Am I Paying For In A Lease?
- How Does Depreciation Work?
- How Do Interest Rates Change The Gap?
- What Lies Beyond The Gap?
- What Is A Total Loss?
- What Matters Is Your Comfort
Who needs gap insurance the most are buyers and lessors stretched to their financial limits to buy a vehicle they can barely afford. They have made relatively small down payments and taken out loans or leases that stretch out a long time. They essentially have “negative equity” in the vehicle from the moment they buy it. And they can’t afford the financial hit of a totaled vehicle if that should happen.
How comfortable are you with this risk? And how much of a risk is it? Read on.
If gap insurance isn’t part of your current policy, ask your insurer if it can be added. This can be as little as a $40 or $50 per year addition to your existing comprehensive coverage. That’s coverage that includes protection for both damage to your vehicle and any liability you may have for damaging another vehicle. And that can be hundreds of dollars less than what gap insurance will cost you through a dealer. If you’re leasing a car or truck, the lessor will require that you carry comprehensive coverage, which protects its interest in the vehicle.
You may also want to assume the risk of a gap yourself. More on that later.
All the elements of insurance policies are worth negotiating carefully with the provider. Are you comfortable with a $1,000 deductible, for instance? Or, should you pay to bring that down to $500? Or wipe out the deductible altogether. This is a whole other topic, but keep it in mind.
Filing a claim is never a pleasant experience. But knowing where you stand makes the misery a bit more bearable.
The collision is your fault. You’re responsible for the damage. Your insurance should be paying for it.
What Is A Closed-End Lease?
Virtually all new consumer vehicle leases today are “closed end” contracts. That is, there’s a stated residual value of the vehicle at the end of the lease that’s agreed upon before the lease is signed. There’s no need to resolve anything at the lease’s end, so you walk away from the car at that point never having to think of it again.
What Is Stated Residual Value?
This is the agreed-upon, projected value of the vehicle at the end of the lease term. The lease’s cost is based on the difference between the purchase price at the start of the lease and the residual value. Most residual values are based on schedules published by companies like Auto Lease Guide. They vary from a specific model and equipment to specific model and equipment. But sometimes leasing companies will add some squish room in the final valuation to give themselves room to negotiate the lease.
What Is An Open-End Lease?
Open-end leases are rarer and usually reserved for commercial vehicles. They usually require a balloon payment at the end of the contract to cover vehicle condition and mileage. The balloon payment represents the difference between the depreciated market value of the vehicle and the amount of the payments that have been made.
As a consumer, it’s extremely unlikely you will encounter an open-ended lease. They are more complex to negotiate and should only be undertaken if you’re confident in your skills.
What Is Mileage Allotment?
This stated value depends on you returning the car in good shape and without exceeding the mileage allotment, which is also agreed upon at lease signing. That’s the number of miles the car will be driven while you have it. As a rule of thumb, start at 1,000 miles per month and negotiate up or down from there.
What Are Additional Mileage Charges?
Mileage charges will be part of the lease contract. Each mile beyond your contract amount will be assessed at a contracted rate. Depending on a vehicle’s value, that can be as little as 15 cents per mile. And from there, the sky’s the limit. There may be room to negotiate this in your contract negotiation — and you should be keenly aware of the limits throughout your lease.
Don’t lease if you don’t have a good read on how many miles you’ll be putting on a vehicle. Leases are best for stable people in stable situations with predictable futures. If you’re a happy-go-lucky wanderer who changes jobs frequently, consider the outright purchase of a vehicle.
Don’t lease if you can’t strictly maintain the vehicle. It’s not your car, but you have a fiduciary responsibility to maintain it. And that responsibility will be in the contract.
What Is An Acquisition Fee?
Leases can include acquisition fees. At the beginning of the lease, expect a charge for several hundreds of dollars charged by the lessor to acquire the car. That’s the acquisition fee. It should be negotiable. Watch out for excessive fees — acquisition charges should be well under $1,000. Zero is best.
Why Does Purchase Price Matter?
Acquisition fees are in addition to the purchase price of the car. Even though the new vehicle is leased, it still must be purchased by the leasing company out of the dealer’s inventory.
What Is A Sub-Vented Price?
On some factory-backed lease deals, this purchase price can be sub-vented; that is, paid down somewhat with a payment from the manufacturer. In other words, the factory throws in a few bucks to make the transaction more attractive — often to hit a price point like “$199 per month.”
What Is Capital Cost Reduction?
Many advertised leases depend on a capital cost reduction payment paid before the lease starts. That is, you, the lessee, pays some amount of cash money up front that reduces the amount the leasing company has to spend to buy the car. That can be several thousand dollars on some advertised leases.
What Is The Manufacturer’s Suggested Retail Price (MSRP)?
The leasing company buys the vehicle and holds title to it. But that doesn’t mean the purchase price can’t be negotiated. There’s no obligation for the lease to be based on the MSRP (more here), which is the number that appears on the federally mandated window sticker. That window sticker is also sometimes known as a Monroney Sticker.
Should I Expect A Discount From The Sticker Price?
Most new cars can be purchased for a discount from the sticker price. But not all vehicles can. Specialized Porsche models, Ferraris and other high-performance exotics, as well as the limited-edition Ford F-150 Raptor pickup, are all notorious for selling at more than the sticker price. In many cases, it may be that the leasing company will be better at negotiating the price than you will be.
What Are Disposition Fees?
Disposition fees come at the end of the lease. That’s the lessor charging to get rid of the car for you. Again, this can be a negotiable charge before you sign the lease. And, the charge should be low — much less than $1,000. What’s more, many leases don’t require disposition fees at all.
Does The Money Factor Matter?
The money factor is the interest rate the lessor is paying on the money it has borrowed to purchase the vehicle you are leasing. Interest rates can vary greatly from institution to institution and some of the lowest may be at credit unions.
You won’t have to pay back the cash money used to buy the car. But you’ll have to pay for the interest on that money used to buy the vehicle.
Knowing the lessor’s money factor is the most straightforward way to compare its rates with other potential lessors. Ask your bank and/or credit union before you lease. Shop around.
What Is A Purchase Option?
Most closed-end leases include a purchase option that allows you to buy the vehicle for the depreciated residual value. If you love the car, great. Buy it. But first check that it hasn’t depreciate below the stated residual value. Because you’re under no obligation to buy it at that price.
Sometimes, though, the end-of-lease vehicle will be worth significantly more than the residual value. That’s a bonanza for you, because the leasing company is contractually obligated to sell it to you at that stated, agreed-upon, depreciated value, determined when the lease was signed. This does not happen often. You can read more about off lease cars here.
What Is The Lease Term?
While most leases last a set term of two, three or four years, you should be able to negotiate a term that meets your particular needs. For instance, if you have a job assignment that will last 19 months, then you should be able to lease a car for that term.
What you pay for in a lease is simply this: the amount of depreciation (D) between the purchase price (PP) and residual valve (RV), minus any paid capitalized reduction (CR), plus the cost of the money factor (MF) used to buy the vehicle, plus any acquisition and disposition fees (ADF), plus any additional mileage charges (MC) minus any sub-vented incentives (I). The monthly payment will depend on how many of those elements are folded into those payments.
So to understand how much a lease is truly costing you each month, the formula is:
Total cost = PP-RV-CR+MF+ADF+MC-I.
Easy, right? Okay, maybe not. But remember, the car dealer and the lessor do this every day. Your best negotiating tool is a sense of modesty. Don’t assume anything, don’t be afraid to ask for help. Oh yeah, good luck.
No car’s value is constant. Virtually all new vehicles (there are exceptions), lose value over their useful lifetimes. Remember that a lease also always involves a purchase agreement.
According to the credit-rating agency, Experian, the average new car loan in the United States as of March 2018 was $31,909. And the average loan on a used car is a stout $19,589. In August, 2018 Kelley Blue Book reported the average transaction price of a new vehicle purchase was $35,359. These numbers are constantly changing, but roughly speaking, that means buyers only put about $3,450 down on their new vehicle.
The instant the average new car drives off the dealer car lot, it loses about 10 percent of its value. That alone wipes out the average down payment — and all the equity in the vehicle is essentially “owned” by the lender who issued the loan to buy it. And right now, according to Experian, the average new-car loan stretches out to 69.2 months. That’s close enough to six years. That’s six years. Six, long years.
So, for at least part of that financed period, the average buyer will owe more on the average vehicle than it’s worth. That’s a gap that can be covered by gap insurance. But the gap won’t last forever.
The moment the gap is bridged will vary depending on interest rates and how quickly a car depreciates. But by the 36th payment on a six-year $31,909 loan with a seven-percent annual percentage rate, there should be $18,057 of debt remaining. And the average $35,359 when-new car should, assuming 20 percent per year depreciation, still be worth $18,104. The gap will have been bridged.
At that point, with the gap bridged, there’s no reason to continue paying for gap insurance. So cancel it.
No, You’re Not “Typical.”
Typical is one thing, but not all vehicles are used typically. For instance, if a vehicle racks up loads of miles quickly, the depreciation may be more radical. That may make the gap wider and insuring against it more crucial. And in some extremely rare cases — like that of the exotic 2017 and 2018 Ford GT supercar — the car is already worth more used than it sold for new.
Self-awareness of your lifestyle, financial status, habits and goals are among your greatest tools in negotiating a lease agreement that works best for you. So be honest with yourself — even when you’re eager to get on the road and chase horizons.
There are literally hundreds of different automotive tax situations and maybe millions of individual financial possibilities. If you have a trusted accountant with whom you work, always consult with them before making any purchasing or leasing decision.
For example, people who can afford very expensive cars are less likely to have financed them (or at least financed less of them) and are often more able to withstand the financial hit of a total loss. They may even pay the entire cost of a lease upfront to save the hassle of making payments or in exchange for a lower interest rate on the money factor. With that much liquidity, why sweat over a few thousand dollars of potential gap problems?
Total loss events for newer vehicles still under a finance contract or lease are actually rare. After all, it doesn’t make sense to junk a car worth $20,000 if $5,000 will fix it.
Most cars that are declared total losses are either stolen or so old — and so drained of value —that it doesn’t make economic sense to fix them.
Maybe surprisingly, the most stolen cars aren’t new ones but older vehicles. The California Highway Patrol, as an example, reported that the top-three most stolen cars in California during 2017 were the 1998 Honda Civic, 2000 Honda Civic and 1997 Honda Accord. And, the most stolen SUVs were the 1998, 1999 and 2001 Honda CR-Vs.
In fact, car theft rates have been declining in the United States for decades. According to the Insurance Information Institute, there were 1.1-million cars stolen during 2007, and that number dropped down to just under 687,000 by 2014. There were slight increases in the number of thefts during 2015 and 2016 (the last years reported), but the numbers are still historically low.
Incidentally, the city with the greatest incidences of motor-vehicle theft during 2017 was Albuquerque, New Mexico. In that medium-size metropolis, 9,989 vehicles were stolen. Meanwhile only 282 cars were stolen in the entire state of Vermont. Few Vermonters ever need to use gap insurance.
It will vary from city to city and state to state, but the chances that your new car will be stolen are low. And if you’re in an accident extensive enough to total your new car, it’s likely you’ll have other problems than worrying about whether your insurance is going to cover the gap of a couple hundred bucks of difference between what you owe on the loan and what your insurance will pay.
We all have different comfort levels with risk. If spending a few bucks on gap insurance will help you sleep at night, it’s money well spent. If you’re in a precarious financial condition that could topple if your new car is wrecked or stolen, shop around and get a great deal on gap insurance. But for many of us, gap insurance is covering a risk so small and remote as to be a nuisance rather than a threat.
It may be that the gap is something you don’t have to worry about it. But if you don’t have to worry, why worry?
It’s tough to be dispassionate about any new vehicle purchase or lease. You’re sitting in a dealership’s “Finance and Insurance” office facing the dreaded “F&I Guy,” who is usually the best salesperson who works there. That person’s job isn’t just to close the deal, it’s to maximize the dealership’s profits by selling high-margin financial and insurance products. It’s a high anxiety moment. And there’s the highway, beckoning you to get on it in your new ride.
The best way to be comfortable with the decisions you make about gap insurance in that office is to slow down, learn the vocabulary of leasing and purchasing, and treat this as just another financial transaction.
Because that’s what it is.