When GAP Coverage Makes Sense for an Auto Loan
Terms like “negative equity,” “upside down,” or “underwater” give borrowers anxiety for understandable reasons. Owing a lender more than what your vehicle is worth can be disheartening. However, as with most things in life, context matters.
It’s not unusual for an auto loan to start with some level of negative equity, especially in the early years of the loan. This happens because vehicles (particularly new vehicles) typically lose value faster than the loan balance decreases at the beginning of the repayment period.
Negative equity typically only becomes a financial problem if the vehicle is totaled or stolen and the insurance payout is less than the remaining loan balance. This is where GAP coverage may help protect a borrower.
Why Many Auto Loans Start With Negative Equity
There are several reasons why a loan balance may be higher than the vehicle value early in the loan:
Vehicles typically depreciate quickly during the first few years
Sales tax, title fees, and other costs are often financed into the loan
Buyers who take longer loan terms pay less each month, which slows the rate of principal repayment but not the rate of vehicle depreciation
Rolling a remaining balance from a previous vehicle into a new loan increases the total loan amount without changing the value of the new vehicle
Smaller down payments mean more of the purchase price is financed
Because of these factors, many borrowers have some negative equity at the beginning of their loan. Over time, as the loan balance decreases and depreciation slows, the loan balance and vehicle value typically move closer together.
What GAP Coverage Does
If a vehicle is totaled, insurance typically pays the current market value of the vehicle, not the remaining loan balance. If the loan balance is higher than the vehicle value, the borrower would normally be responsible for paying the remaining difference out of pocket.
GAP (Guaranteed Asset Protection) coverage may pay the difference between the insurance payout and the remaining loan balance, which can prevent a borrower from continuing to make loan payments on a vehicle they no longer have.
Who Should Consider GAP Coverage
GAP coverage may make sense in situations where negative equity is more likely or may last long into the loan term. This can include car buyers who:
Make only a small or no down payment
Take a long loan term
Roll negative equity from a previous vehicle into a new loan
Finance taxes, fees, warranties, or add-ons into the loan
Purchase a new vehicle that depreciates quickly
In these situations, the loan balance may remain higher than the vehicle value for a longer period of time, which increases the risk if the vehicle is totaled during that time.
Who Might Not Need GAP Coverage
GAP coverage may be less necessary in situations where the loan balance is likely to stay close to or below the vehicle value. This may be the case for buyers who:
Buy a preowned vehicle that has already gone through most of its depreciation
Make a large down payment
Take a shorter loan term
Pay extra toward the principal balance to keep the loan balance lower than the vehicle value
GAP coverage is an unnecessary expense if you’re not underwater, since claim payouts for a stolen or totaled vehicle will usually be enough to cover what you still owe on your auto loan.
Get Honest Answers From an Auto Lender Who Puts You First
GAP coverage is not necessary for every auto loan, but it can provide vital protection if you are going to be underwater on your auto loan for a couple of years. The right decision depends on your down payment, loan term, vehicle type, and overall loan structure.
Ouachita Valley FCU offers GAP protection on auto loans and can help you review your loan options so you can make an informed decision about whether GAP coverage makes sense for your situation. Call 318.387.4592 to speak with a local auto loan professional.
