If you’re leasing a vehicle, at some point you’re almost certainly going to be on the receiving end of a sales pitch for GAP insurance. If it’s not the motor dealer or agent that does it prior to you taking delivery of the vehicle, it’ll be the motor dealer’s customer services team or, the finance company themselves that contact you by letter, email or phone once you’ve already taken delivery. If you’re really “lucky” – it might be ALL of them! But do you need GAP insurance for a leased vehicle? The answer is… not always, no!
First of all, let’s deal with the common elephant-in-the-room…
What Is a Contract Hire / Lease Agreement?
To clarify, by “lease”, I’m referring to a Contract Hire Agreement under which you have no contractual option to purchase the vehicle. It’s an agreement whereby you pay an “Initial Rental” (normally a multiple of 1, 3, 6 or 9 times your regular monthly rental) then a further 23, 35 or 47 regular monthly rentals, after which you return the vehicle to the finance company.
What I’m not referring to, is a personal loan, HP, PCP or Lease Purchase agreement by way of which you are purchasing the vehicle and upon making the last repayment, become the owner of it.
Why Would You Need GAP Insurance?
In the event that your vehicle is written off during the term of your Contract Hire / Lease agreement, what would normally happen is as follows:
Your motor insurer will:
- Calculate what they think your vehicle is worth at the time of loss.
- Pay the value of the vehicle to your finance company (less any excess you have to pay under your motor insurer)
Separately, your finance company will (generally) then:
- Calculate what they think your car is worth
- Add to the above, the combined sum of any rentals that have not yet been paid for the remaining duration of the Contract Hire Agreement.
- They’ll often then apply some form of fee for wrapping the agreement up early.
- They sometimes then apply a small discount (not usually more than 4%) for early settlement.
Note: The finance company may well apply further costs for maintenance, excess mileage charges and arrears (if/when applicable) – to be clear, costs for such things would not normally be covered by any GAP insurance policy.
The figure calculated by the finance company will become your settlement figure or, in lease-terms, your “Early Termination Fee”.
GAP insurance (specifically Contract Hire GAP insurance) would then be called upon to pay some or all of the difference (shortfall) between your motor insurance payout and the early termination fee of the contract hire agreement. The ultimate goal being (subject to the policy terms, conditions, exclusions and claim limit) to leave you in a cash-neutral position – e.g. no car, but no debt either.
The theory is that without GAP insurance, not only would you be needing to organise a new lease on a new vehicle but, you’d have a debt to settle in relation to the lease on the previous vehicle too.
Why WOULDN’T You Need GAP insurance?
This is where it gets interesting. You see, in calculating the Early Termination Fee, the finance company are almost certainly going to create a shortfall – if they’re calculating the present-day value of the vehicle (as the motor insurer would) and then adding anything to it, there is naturally going to be a shortfall between the figure arrived at by your motor insurer and the figure arrived at by your finance company. The key though, is whether you’re liable for that shortfall.
It varies between finance companies but as a rule, the terms of your lease agreement will see you fall in to one of three possible categories:
- You’re liable for ALL of the shortfall.
- You’re liable for SOME of the shortfall.
- You’re liable for NONE of the shortfall.
Clearly, if you’re liable for ALL of the shortfall, it may well be prudent to at least consider GAP insurance as a way to mitigate your financial exposure. For example, if your vehicle was written off when you had say, 30 rentals of £250 left to pay, would you be able to fund – out of your own pocket – the £7,500 shortfall (albeit without accounting for any potential discount) plus you’d also need to fund a further initial rental that you’d need to start a new lease agreement on a replacement vehicle?
If you’re liable for SOME of the shortfall (it’s relatively common to see agreements holding you liable for 50% of the shortfall) you may decide that GAP insurance isn’t something you wish to consider. For example, using the same figures as above, with 30 rentals of £250 left to pay, 50% of the shortfall would be £3,750 plus you’d also need to fund a further initial rental that you’d need to start a new lease agreement on a replacement vehicle.
It might be that you’re able to stand the £3,750 yourself or at least, would be happy to take the risk of needing to do so without wanting to pay a premium to insure against it. Note too though that I’ve based the above figures at 50% of the shortfall when in fact this percentage varies between finance companies too. In fact I saw one lease agreement a short while ago that would only hold “you” liable for £25 per monthly rental outstanding (not the sum of the rentals themselves). If that was the case with 30 rentals remaining to be paid when the vehicle was written off, that’d present a shortfall of just £750!
In this case you might decide to buy a minimal level of GAP insurance cover… or potentially go entirely without it – your attitude towards the risk and ultimately whether you wish to protect against it would be key.
Finally, if you’re liable for NONE of the shortfall and are allowed to simply walk away with nothing else to pay (something I have experienced when my own leased vehicle was written off in December 2014), would you buy GAP insurance at all? Well… possibly. There’s the small matter of the excess deduction made by your motor insurer and the initial rental that you paid but, put that aside for the time being… I’ll come back to it.
For now though, we need to delve a little further still…
All of the above is based on the assumption that the finance company are going to calculate the value of your vehicle as the present-day market value (just as your motor insurer would). However some lease agreements are such that the finance company would calculate the value of your vehicle based on what they expect it will be worth at the end of the lease agreement – often referred to as the “Anticipated Residual Value” (plus some or all of the outstanding rentals etc as above).
This being the case, if (as above) your vehicle was written off 6-months in to a 36 month lease agreement, the present-day market value of your vehicle (paid out by your motor insurer) is likely to be considerably higher than the Anticipated Residual Value of your vehicle at the end of the 3rd year therefore, the excess could/would be used towards the additional sum required in relation to the as yet unpaid rentals and in many cases would probably cover the “shortfall” entirely and if it’s an agreement which would see any surplus funds paid out by the motor insurer refunded to you (some finance companies retain surplus funds, sadly), it’s possible that you’d have money paid to you that would go towards covering some or all of the Initial Rental you’d need to pay for starting a new lease agreement on a new vehicle.
Other Things To Consider
When you start a lease agreement you have to pay an Initial Rental which, (as described above) is normally a multiple of 1, 3, 6 or 9 times your regular monthly rental. If your vehicle was written off during the term of that lease agreement, unless you’re fortunate enough to have surplus funds paid out by your motor insurer refunded to you (see the last paragraph above), you’re going to have to walk away from Initial Rental that you paid and find funds for starting a new lease agreement out of your own pocket.
Separately your motor insurer may have deducted an excess from your motor insurance policy claim and again assuming you’re not having any surplus funds paid out by the motor insurer refunded to you, you might find that you’re having to fund the excess deduction out of your own pocket too.
GAP insurance can help with both of the above scenarios… e.g. as part of a GAP insurance claim our policies will contribute up to £250 towards any motor insurance excess you had to pay plus, you can pay a small additional premium at the time of buying a GAP insurance policy to ensure that you’re reimbursed up to £3,000 of the initial rental that you paid when you started the lease agreement on the now written off vehicle.
Thus, if your lease agreement is such that there’s likely to be a shortfall of any kind, even if minimal, you may decide to take GAP insurance primarily in relation to the potential excess deduction and/or Initial Rental paid – obviously subject to the sums involved Vs the cost of the GAP insurance policy premium.
It pays to read and understand the terms of your lease agreement in order to ascertain what (if any) need exists for GAP insurance. Depending on the terms of your lease agreement, you’d either need to consider:
- A high level of cover if there’s the potential for a high financial exposure on your part.
- A medium level of cover if there’s the potential for a medium financial exposure to you.
- A low level of cover if there’s the potential for a low financial exposure to you.
- No GAP insurance cover whatsoever.
Obviously, peace of mind is key, but at what price? Do you over-insure just in case and spend money you don’t need to or, do you approach it tactfully and only spend the money you need to in order to achieve that peace of mind, even if that peace of mind means you don’t need to spend a penny on GAP insurance at all?
We’re in the business of making sure our customers get the right GAP insurance policy for their needs, at the right price and if that means no GAP insurance policy at all, so be it.
If you’re struggling to comprehend whether you need GAP insurance for your lease agreement at all, get in touch with us. We’ll review your lease agreement, give you our interpretation and point you in the direction of a policy that best suits your needs – all without any obligation on your part.
Thank you for reading, and I hope this helps.
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Who am I?
I founded the UK’s very first independent online provider of GAP insurance back in March 2004 and this has evolved into the GAPinsurance.co.uk that you see today. Over those years I’ve been the champion of the UK car-buying consumer, doing my best to help them avoid being overcharged by and/or mis-sold to by motor dealers charging vastly inflated prices for what are often sub-standard GAP insurance policies. In the face of increasing competition from companies offering budget policies (via insurers who have ultimately gone bust), I’ve led the way with market-defining policy refinements and at all times stuck with large A-rated insurers with the financial clout to ensure they’ll still be around if/when the need to claim arises. I don’t, and never will, offer budget policies. I offer the right policies, at the right price.