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When to Choose GAP Insurance and Vehicle Extended Warranties

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Buying a car or truck can make a big dent in your budget.

To keep yourself on firm financial ground in case of the unexpected, you may want to consider Guaranteed Asset Protection (GAP) insurance and an extended warranty for your vehicle.

Let's take a look at these optional protection plans and how they can help you save money.

What Is GAP Insurance?

GAP insurance is supplemental car insurance that bridges the "gap" between the amount your standard comprehensive and collision insurance will cover if your vehicle is stolen or totaled in an accident and the balance you have remaining on your auto loan or lease. Optional GAP coverage must be purchased at the same time as you buy or lease a new car, and you must be the vehicle's first owner or leaseholder.

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How GAP Insurance Works

If your car is stolen or deemed a total loss following a wreck, your insurance plan will typically pay actual cash value (ACV), minus your deductible, to replace it. ACV is the amount the insurance company determines someone would reasonably pay for your car if the theft or accident had never occurred. Actual cash value takes into account:

  • Depreciation
  • Mileage
  • Wear and tear
  • Mechanical problems
  • Cosmetic condition
  • Supply and demand

In some cases, the ACV settlement you receive from your insurer might not be enough to replace your car with an equivalent vehicle and pay off the remainder of your original loan or lease. This could leave you stuck making payments on a vehicle that you don't have or can no longer drive. That's where GAP insurance comes in.

Once you’ve paid down the loan to the point where the car is worth more than you owe, you should remove the GAP coverage.

Let's say you bought a new car for $30,000 but you still owe $25,000 on your loan when you're involved in an accident. After assessing the damage, your insurance company declares your vehicle a total loss and agrees to pay you the car's depreciated value, which in this instance is $20,000.

Everything seems fine until you receive a check for $19,500 — the amount of the settlement minus your $500 deductible. That's when you realize you'll have to shell out $5,500 of your own money to pay off your loan balance. And you'll still be without a car to drive.

If you had been carrying GAP insurance on the vehicle, it would have covered the $5,500 difference. You'd still have to make arrangements to buy a new ride to get back on the road, but at least you wouldn't be paying off a totaled car.

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How Much Does GAP Insurance Cost?

You can purchase GAP insurance through the dealership or lender that's financing your car or directly from an insurance company. Typically, coverage costs between $400 and $700 when wrapped into your loan by the dealer and between $20 and $40 per year if you add it to your auto insurance policy.

Infographic on when you might need GAP coverage

Do I Need GAP Coverage?

Generally, GAP insurance makes a lot of sense if you:

  • You finance your vehicle with less than 20% down
  • Put a lot of miles on your vehicle, which decreases its value more quickly
  • Purchase a luxury car or SUV — they depreciate faster than less expensive vehicles
  • Extend your loan beyond 60 months to keep your payments lower
  • Trade in a car and roll the balance of the old loan into the new car loan

GAP coverage is also a good idea — in some instances, even a requirement — if you lease rather than buy a car or truck. That's because the market value of the vehicle would likely be lower than the amount still owed on the contract if the car was stolen or totaled during the lease period.

If you opt for GAP insurance, keep in mind that you probably don't need to carry it the entire time you have the vehicle. Once you've paid down the loan to the point where the car is worth more than you owe, you should remove the GAP coverage. GAP insurance wouldn't pay any additional reimbursement if the car was stolen or totaled.  

Optional GAP coverage must be purchased at the same time as you buy or lease a new car, and you must be the vehicle’s first owner or leaseholder.

What is an Extended Warranty for a Car?

An extended warranty for a car is exactly what its name suggests: additional coverage you can purchase to lengthen the amount of time your vehicle is covered under a standard factory warranty. Extended warranties are sometimes referred to as vehicle service contracts or vehicle protection plans.

Extended warranties function a lot like medical insurance for your vehicle. They're designed to offset what could otherwise leave you with some hefty repair bills should major issues arise.

How Extended Vehicle Warranties Work

First things first, when you buy a new car, it usually comes with bumper-to-bumper and powertrain warranties from the manufacturer.

  • Bumper-to-Bumper Warranties: Most bumper-to-bumper warranties last for three years or 36,000 miles and cover all of the vehicle's mechanical systems and components, as well as onboard computers, the HVAC system, and various other electronics.
  • Powertrain Warranties: Powertrain warranties, on the other hand, guarantee the automobile's engine and transmission against defects in workmanship. This coverage usually expires after five years or 60,000 miles.

What to consider when buying your teen their first car.

Generally, if something covered by an extended warranty breaks down and needs replacement or repair, you can take the car to an authorized shop and have it fixed free of charge or for the cost of the plan's deductible. It's worth noting that extended warranties typically don't pay for routine maintenance or damage caused by normal wear and tear.

How Much Do Extended Vehicle Warranties Cost?

You can purchase an extended warranty through the dealer for roughly $2,000 to $3,000. They'll usually fold the cost of the warranty into the loan, allowing you to pay for it over time.

If that price tag has you choking a bit, consider extended warranty options from an outside company. You might be able to find an attractive, reasonably priced alternative without going through the car seller.

It's also a good idea to call a few finance and insurance managers at other dealerships in your area to find out what they charge for extended warranties. This will give you a good frame of reference and provide some leverage when negotiating (yes, extended warranties are negotiable).  

A leased vehicle will remain under the factory warranty throughout the time you drive it.

Do I Need an Extended Warranty?

When deciding if you should purchase an extended vehicle warranty, ask yourself this question: If you run into a major car problem, could you afford to handle it or would it throw you into financial chaos?

Ideally, you'd have a cushy emergency fund to take care of unexpected repairs. However, if you don't have a lot of money set aside for a rainy day (or none at all), an extended warranty can help protect your budget, keep you from taking on high-interest credit card debt, and provide some peace of mind.

Purchasing an extended vehicle warranty may also be a good move if you:

  • Plan to keep your vehicle longer than the length of your factory coverage
  • Buy a newer car or truck that's heavily equipped with computers and electronics
  • Purchase a make or model that has a history of being unreliable
  • Tend to worry a lot about the what-ifs

You don't need an extended warranty when leasing a vehicle unless you plan to buy it outright once the lease period ends. A leased vehicle will remain under the factory warranty throughout the time you drive it.

Extended warranties are sometimes referred to as vehicle service contracts or vehicle protection plans.

The Takeaway

GAP insurance and extended warranty plans are both designed to cover expensive car repair costs and ultimately save you money, but they aren't for everyone and every situation.

Before purchasing any type of insurance take an honest look at your financial situation and consider how much risk you're willing to take. Then, you can decide and ride with confidence, knowing that you've done all you can to protect yourself and your auto investment for years to come.

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