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GAP Insurance: Don’t be Confused by a Clever Acronym

January 25, 2013

The cleverly named Guaranteed Auto Protection (GAP) policy provides insurance that will reimburse you for the difference between the cash value of a lost or totaled vehicle and the remaining balance owed on the vehicle’s financing (car loan, lease, etc.). In effect, a GAP policy helps you cover any “gap” that may exist between the actual value of your car at the time of loss (taking into account depreciation) and the amount you still owe to the financing company. Hence, the clever acronym G-A-P.

Here’s one example of how a GAP policy might work:

1.  You purchase a car for $20,000.
2.  You make a down payment of $2,000 and now owe a balance of $18,000 to be paid in 4 years ($375 monthly payments).
3.  You purchase an auto policy covering physical damage (comprehensive and collision) that grants a $500 deductible as protection against any damage.
4.  You then get into an accident and your car is totally destroyed.
5.  While you still owe $17,500 on the car the insurance company decides that your car, now considered a used car, is worth only $16,000 in cash.
6.  GAP insurance will cover the $1,500 difference between the appraised value of the car and the payment balance.

In the example above, we excluded interest, dealer fees, etc. to simplify the math, but this picture still serves to illustrate how GAP insurance can be a valuable precaution for people or businesses that plan to lease or finance a vehicle. Some financing companies even require GAP coverage as a condition for obtaining a loan. This requirement helps protect the financing company’s interest in the lost or damaged property.

Now, here’s where things get a little confusing: some use the phrase “gap insurance” (notice the lower-case “gap”) to refer generally to any type of policy that offers extended coverage over and beyond the amount already covered by another policy. This makes sense since the purpose of such policies is to ensure there are no “gaps” in coverage.  GAP insurance may be a specific example of this type of policy, but so are “umbrella” policies which deal primarily with liability and other types of costs.

GAP Insurance (uppercase G-A-P) has a specific industry meaning that addresses the auto concerns outlined above. However, a person leasing or financing a car may not think they need optional GAP Insurance if they believe it’s meant to cover liability gaps. “I already have a personal auto policy with substantial liability limits” you might think “why would I need ‘gap insurance’?” and be totally unaware of the risk GAP Insurance is meant to cover.

So, don’t be confused by a nifty acronym. GAP Insurance is an important tool for individuals or businesses leasing or financing their vehicles. It’s a precaution that often gets overlooked because it’s confused with other types of insurance policies. For that reason, the people who invented the name “GAP Insurance” might have been a little too clever.

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