The Ultimate Guide to GAP Insurance Explained
Ever wonder what GAP insurance is? Let me start by sharing a short story. At 18 years old and a freshman in community college, one of the things I desired most was a brand-new truck. I had purchased an old truck while in high school. I never had a new vehicle and for some silly reason the cool thing to do was having a new vehicle at a young age. In my mind, I was grown and was a working college student. I should be able to have what I desired. So, I wound up buying a semi-new Ford F150 and it was very nice.
Now comes the bad news, I got into a wreck in the vehicle driving home from work early one morning. This was a terrifying experience for me as I fell asleep at the wheel and hit a tree. That was a lesson learnt for me, I never drive while tired now! Fortunately, I was ok and sustained no injuries. On the other hand, the truck did not make out so well, it was totaled. My heart was broken as I had lost my prize possession. Little did I know, there was more bad news. When I originally purchased the vehicle, I was asked if I wanted something called GAP insurance or coverage, which I declined.
Consequently, I had a debt of around $10,000 to $15,000 on my credit report for about 10 years. This situation had a negative affect on my life for some time. I was able to build my credit, and that debt eventually fell off. I am sharing this personal story to let all readers know that GAP insurance is important, and if you are not informed about it, I will get you some great information now.
What is GAP insurance?
GAP insurance is a type of optional auto insurance that assists in paying off a car loan if the car is totaled or stolen. The original purchaser or leaser of the new vehicle is the only one who can buy GAP insurance. The purpose of GAP insurance is to make sure that, in the event of an accident that totals a vehicle or theft of a vehicle, the remaining amount that is you owe on the vehicle is paid off. When you have GAP insurance you want to use it with your collision coverage and comprehensive coverage. Collision coverage helps pay for car repair or replacement if your vehicle is in an accident with another object.
Collision Insurance
Below are some examples of accidents that would collision insurance covers:
- Collision with another vehicle
- Collision with a tree, gate, or roadway barrier
- An accident that involves a vehicle falling over or rolling over
Comprehensive Insurance
Comprehensive insurance helps pay for car repair or replacement if your vehicle is stolen or has damages in a situation that does not involve another object. Below are some examples of vehicle damage that is comprehensive insurance covers:
- Theft
- Fire
- Vandalism
- Damage from hurricanes, tornados, flood or any other natural disaster
- Damage from animals
- Civil disturbance damage such as riots
To have collision and comprehensive insurance is great, but there is only one problem; these insurances only cover the depreciated value of a vehicle. The depreciated value of a car is the vehicles current value after accounting for reduction in value due to normal wear and tear. Although this may sound ok, in many cases the depreciated value of an automobile can be much less than what the loan or lease total remaining on the vehicle is. This is where GAP insurance comes in as it will then cover the difference between the loan or lease amount and what collision or comprehensive insurance cover. Here is a below example of how this all works.
Ex. Vehicle Loan/Lease remaining balance = $20,000
Depreciated Value = $16,000 – covered by collision / comprehensive insurance
Difference and amount that Gap insurance will cover = $4,000
Is it worth the money?
The most accurate answer to this question is, it depends. When you package with collision and comprehensive coverage, the cost of GAP insurance ranges from around $20 to $40 per year. This is if you have bought it from a major insurance company. When you buy stand-alone GAP insurance from a major insurance company, the cost is around $200 to $400. If you purchase through a lender, the cost is normally around $400 to $700. The following questions are important to consider when you decide whether GAP insurance is worth having.
- What is the market value of my vehicle when comparing to the amount I owe on my vehicle at the time of purchase?
- This difference is significant compared to the cost of GAP, then it may be worth having.
- Are the terms of your auto loan over 2 years?
- If the answer is yes, then chances are that the depreciation of the vehicle will outpace your paying down of the auto loan, so GAP insurance may be worth having.
- Do you or will you be driving the vehicle a lot?
- If the answer is yes, then the value of the vehicle is reduced at a faster than normal rate, which means GAP insurance may be worth having.
- Does the vehicle you purchase depreciate faster than normal.
- If the answer is yes, then GAP insurance may be worth having.
- Are you leasing the vehicle?
- If the answer to this question is yes, then because the market value of the vehicle is generally less than what it is worth to the dealer that you are leasing, GAP insurance may be worth having.
Can car GAP insurance be deducted on Schedule C?
For individuals who use a vehicle for business, you can deduct GAP insurance expenses. The amount that can be deducted is dependent on the percentage used for business. For example, if the GAP insurance cost $500 and the percentage business use of a vehicle is 50%, then the deduction for GAP insurance would be $250.
If you are someone who wants or needs information about GAP insurance, I hope that the information in this post is helpful to you. For additional details on GAP insurance see the following link. If you still have further questions or want to discuss it further please contact a Molen and Associates Tax Advisor for assistance.
Arthur Harris
Tax Advisor, Accountant, EA
