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Re: Poll: Gap Insurance - Foolish?

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By joelcorley
October 6, 2004

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Patzer,

You wrote, I never heard of Gap Insurance before this thread. From the context, I assume it's insurance to pay off your upside-down auto loan if the car gets totaled? Or is it a broader concept to get true replacement cost for the car instead of market value?

Gap Insurance is there to protect the lender. It's like credit life insurance or MIP on a mortgage. If you total your car, it pays the difference between the loan and the insurance settlement.

When you receive an insurance settlement check on a totaled vehicle that has a lien on it, the insurance company must include the lender as a payee. You must then send that check to the lender for endorsement, cashing or repayment of the lien, depending on whether the vehicle is totaled and the loan was upside down. If the vehicle was totaled and the settlement was insufficient and you purchased gap insurance from the lender, the lender must look to it's own reserves or to a 3rd party insurer for the difference.

If you failed to purchase gap insurance, you must pay for the difference out of your own resources immediately or risk the lender placing the balance into collection.

Also, 1) Never get an upside-down loan in the first place. If you can't make a big enough down payment to cover the depreciation of driving off the lot, don't buy new.

It's not always possible to guarantee a loan will remain right side up by simply putting up any old down payment. In reality, a vehicle's value declines along a concave curve. The curve is steepest when it's new; but the shape remains concave until the vehicle is fully depreciated.

Paying down a loan always produces a convex curve. Even if you put up a down payment, it's possible for the loan balance to eventually intersect the present value of the vehicle, at least for a time. The only time this isn't true is if the vehicle is fully depreciated at purchase, or if the down payment is large enough to compensate for the maximum conceivable depreciation rate.

On the other hand, gap insurance seems to be priced based on the balance or even on nothing at all and not on what would make sense � how upside down the loan might be at a given moment. If gap insurance were based on such a measure, I might be more inclined to take it seriously. As it is, I've purchased 7 vehicles in my life and financed 6. I may have been lucky; but I've never purchased gap insurance and if I had, I would never have been able to claim on it � even though my XSO did total a car or two during our marriage.

All in all, I think gap insurance is probably a scam. Even if you do take advantage of 100% financing, you should never get yourself in so deep with a car that if it were totaled you couldn't pay off the portion you are upside down on. Letting yourself get into that position just seems foolish to me and that's with a little 'f'.

- Joel


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