Gap insurance is advisable for some used car owners. The main determining factors are 1) the value of the vehicle, 2) the amount financed, and 3) the length of the loan. Basically, when many people finance a vehicle, there is a gap between what the car is worth, and what is owed on the loan. This is called negative equity, and it is exacerbating by longer lending terms and higher interest rates.
Certified Pre-owned Vehicles
Many people who look for used vehicles try to lower their risk by buying a certified used car from an automaker’s CPO program. These vehicles are a good investment due to the mileage, age, and maintenance guidelines that have to be followed in order to become ”certified.” Unfortunately, they are more expensive than comparable used cars that are not certified. This usually means that you will have to borrow more money, leaving you open to a significant gap between the value of a vehicle and the balance owed. If the gap is large enough, a lender will require that you carry ”gap insurance” to make sure the vehicle will be paid off in the event of accident that destroys the vehicle. Even if it is not required by your lender, gap insurance may be advisable for the same reason.
One segment of the auto buying populace that often faces a large gap between the value of a financed vehicle and the loan’s balance are people who have bad credit. Because of their credit score, they are charged higher interest rates, which causes the large balance/value gap.
Down Payment vs Gap Insurance
You may be able to avoid the need for gap insurance by offering a higher down payment. If you have a good credit score, you may only need a down payment of five percent in order to secure a loan, but it would be in your best interest to offer closer to twenty percent. You will save by paying less interest over the life of the loan and possibly avoid the need for gap insurance.
Boosting Credit to Improve Lending Terms
If you have bad credit, your best chance to avoid gap insurance is to clean up your credit report, raising your credit score. Order your credit reports at www.annualcreditreport.com. Look for errors, then dispute them. After that, try to pay off any collection actions. One option to raise your score is to obtain a credit card. Even the worst credit scores can obtain a secured credit card. After making 12 on-time payments and keeping your balance under 20 percent of your credit limit, your credit score should have raised enough to allow you to get better loan terms and possibly avoid the need for gap insurance.