What Is Gap Insurance and How Does It Protect You?
Gap insurance, also known as Guaranteed Asset Protection, covers the financial gap between what your comprehensive car insurance pays out if your vehicle is written off or stolen, and what you still owe on your car loan. Standard car insurance pays the current market value of your vehicle at the time of loss, which due to depreciation is often less than your outstanding loan balance.
Without gap insurance, you could face a scenario where your car is totalled, insurance pays out $25,000 representing the vehicle's current value, but you still owe $32,000 on your loan. You would be personally liable for the $7,000 shortfall while simultaneously needing to fund transportation, potentially including another car and another loan.
Gap insurance eliminates this risk by paying the difference between the insurance payout and your loan balance. In the scenario above, gap insurance would cover the $7,000 gap, allowing you to walk away from the written-off vehicle without ongoing debt.
When Gap Insurance Makes Financial Sense
Gap insurance is not necessary for every car buyer, but certain situations make it particularly valuable and worth the cost.
Small or No Deposit: If you financed your car with little money down, you start your loan with minimal equity. The vehicle's value immediately begins dropping while your loan balance decreases slowly in the early years when most of your payment goes toward interest.
Long Loan Terms: Loans extending beyond five years increase your risk of negative equity. The longer your term, the longer you remain in a position where you owe more than the car is worth. Use our car finance calculator to see how different loan terms affect your repayment schedule and equity position.
New Vehicle Purchases: New cars experience their steepest depreciation in the first few years. A new car can lose 20 to 30 percent of its value in year one alone, creating a significant gap between market value and loan balance.
High-Depreciation Vehicles: Some makes and models depreciate faster than others. Luxury vehicles, certain imported brands, and cars with poor reliability reputations often lose value rapidly, increasing gap risk.
High-Kilometre Drivers: If you drive significantly more than the average 13,000 kilometres annually, your car will depreciate faster than average due to increased wear and higher odometer readings.
Understanding the Different Types of Gap Cover
Gap protection products in Australia come in several forms, each with different features and coverage levels.
Finance Gap Insurance: The most common type covers the difference between your insurance payout and your loan balance at the time of loss. This ensures you can pay off your existing debt but does not provide additional funds for a replacement vehicle.
Return to Invoice Gap Insurance: This covers the gap between the insurance payout and the original purchase price of your vehicle. If you paid $45,000 for a car that is now worth $30,000 and is written off, you receive enough to cover both your loan and potentially a deposit on a replacement vehicle.
Return to Value Gap Insurance: This type pays the difference between the insurance payout and an agreed value set when you take out the policy. The agreed value is typically close to the purchase price and provides certainty about your coverage level.
Read policy documents carefully to understand exactly what is covered. Some policies have caps on the maximum gap payment, exclusions for certain circumstances, or requirements about maintaining comprehensive insurance with approved insurers.
How Much Does Gap Insurance Cost?
Gap insurance pricing varies based on the type of cover, the insurer, and the value of your vehicle. In Australia, you can expect to pay anywhere from $300 to $1,000 for a typical gap insurance policy covering a standard consumer vehicle.
Many car dealers offer gap insurance at the point of sale, often as part of a finance package. While convenient, dealer-sold gap insurance is frequently more expensive than policies purchased directly from insurers or through insurance brokers. Always compare prices before accepting a dealer's offer.
Some lenders bundle gap insurance into their car loan products, either as an included feature or an optional add-on. Check whether your loan includes this coverage and compare its value against standalone policies.
When evaluating cost, consider the maximum gap you could face. If your potential gap exposure is $8,000 and gap insurance costs $500, the risk transfer represents reasonable value. However, if your gap risk is only $2,000 due to a large deposit, paying $500 for coverage may be less attractive.
Alternatives to Gap Insurance
Gap insurance is not your only option for managing the financial risk of negative equity. Consider these alternatives based on your circumstances.
Larger Deposit: A substantial deposit immediately creates equity in your vehicle, reducing or eliminating the gap between loan balance and market value. If you can put 20 percent or more down, you may never experience significant negative equity.
Shorter Loan Term: Choosing a shorter loan term means faster principal reduction. While your monthly payments will be higher, you build equity more quickly and spend less time in a negative equity position.
Market Value Insurance: Some comprehensive insurers offer agreed value policies where the payout amount is agreed when you take out the policy rather than determined at claim time. This does not cover loan gaps but provides certainty about your payout.
Self-Insurance: If you have significant savings, you might choose to self-insure against the gap risk. Set aside funds equivalent to your potential gap exposure and invest the gap insurance premium savings elsewhere.
Making Your Decision: Is Gap Insurance Right for You?
To determine whether gap insurance makes sense for your situation, calculate your potential gap exposure and weigh it against the cost of coverage.
Start by using our car finance calculator to model your loan and see your projected balance over time. Research the expected depreciation for your specific vehicle using resources like Redbook to estimate its future market value.
Compare these figures year by year throughout your loan term. If there are periods where your loan balance significantly exceeds the expected market value, you have gap exposure that insurance could protect against.
Consider your personal risk tolerance and financial resilience. Could you absorb a gap shortfall of several thousand dollars if the worst happened? Would such a loss significantly impact your financial stability?
Finally, shop around for gap insurance quotes rather than accepting the first offer. The right policy at the right price provides valuable peace of mind during the period when your financed vehicle is most vulnerable to the gap risk.
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Car Finance Calculator Team
Our team of finance experts is dedicated to helping Australians make informed decisions about car loans. We provide accurate, up-to-date information to guide you through your vehicle financing journey.