California cracks down on auto loan GAP coverage

California this month established new limits on guaranteed asset protection sales with two new laws, including one an opponent predicted would reduce GAP sales to service members.

Assembly Bill 2311, signed into law Sept. 13 by California Gov. Gavin Newsom, caps the price of GAP and bans its sale in certain situations. It also requires lenders to refund charges automatically when consumers cancel the finance-and-insurance product or pay off their auto loans.

GAP coverage pays any loan balance not reimbursed by traditional auto insurers, who are only obligated to cover the vehicle's actual value, in the event of a total loss. Like other F&I products, it is often bundled and financed within auto loans rather than purchased separately.

But Senate Bill 1311 would void a lender's security interest in a vehicle if "the loan also funds the purchase of a credit insurance product or credit-related ancillary product" sold to a service member. Coverage including GAP and credit life/accident and health insurance, which handles debt if something disastrous happens to the borrower, would seem to fall under the scope of this language, according to Stephen McDaniel, founder and CEO of compliance provider F&I Sentinel.

SB 1311 passed both chambers of the California Legislature unanimously in August and reached Newsom on Aug. 30. The Democratic governor announced Tuesday he had signed it.

Guaranteed Asset Protection Alliance Executive Director Tom Keepers argued last week that the Legislature had created a new regulatory framework for GAP with House Bill 2311 yet prevented the military from buying the product with Senate Bill 1311.

"It's really kind of a cruel irony," he said.

AB 2311 bans GAP sales on California car loans for less than 70 percent of a vehicle's value or which finance more than GAP would cover, and it caps the price of GAP at 4 percent of the amount the borrower finances. The average new-vehicle loan financed $40,290 during the second quarter, while the average used-vehicle loan involved $28,534, according to Experian.

Car deals with loan-to-vehicle-value ratios above the loan-to-value ratio limit in the GAP policy would still be permitted if buyers are notified of this imbalance "in writing, acknowledged by the buyer," the bill states.

The measure also requires GAP buyers to sign off on a separate form notifying customers the finance-and-insurance coverage and other add-on products are always optional, and it gives consumers the right to cancel GAP at any time without a fee.

"The sale of GAP waivers is just one example of vulnerable customers being taken advantage of when committing to a large purchase," bill sponsor Assembly Member Brian Maienschein, D-San Diego, said in a statement Sept. 14. "AB 2311 will strengthen California's consumer protection laws to ensure that car buyers can avoid the costly add-on when unnecessary."

University of Michigan Survey Research Center polling in 2020 found GAP products attached to about 39 percent of financed vehicles, according to a paper by two economists and a University of Mississippi finance professor analyzing the results. More than 90 percent of those covered by GAP said they thought the purchase was a good idea, according to the paper.

Auto lenders will need to be ready to automatically refund the GAP payments they've financed up front during a car deal should certain conditions described in the law arise.

A GAP contract is considered terminated and a refund due under AB 2311 if the consumer cancels the coverage, the vehicle is repossessed or the loan is repaid. The customer must receive a full refund within the first 30 days of the GAP policy's life; after that, only a prorated amount is required.

The lender must either return the money to the customer or direct the GAP providers to do so within 60 days of a GAP contract's cancellation. However, lenders also have the right to simply refund the remaining auto loan balance.

McDaniel, whose company reviews F&I products for lenders considering financing them within auto loans, said lenders have begun to establish partnerships with GAP providers to facilitate such refund obligations. GAP middleman firms also can bring the two industries together for the transactions, according to Keepers.

Worst case, lenders could simply refuse to finance GAP from unresponsive product providers, McDaniel said.

AB 2311 first passed the California Assembly 52-16 on May 25. An amended version cleared the California Senate 32-0 on Aug. 24, and the Assembly agreed to the amendments in a 60-3 vote Aug. 25.

Keepers said GAPA was able to work with AB2311 sponsor Maienschein and the office of bill champion California Attorney General Rob Bonta on more palatable legislation than was introduced.

Originally, the measure capped GAP pricing at 2 percent of the amount borrowed, banned GAP on loans for less than 80 percent of vehicle value and forbade GAP contracts that covered less than the sales contract's loan-to-value ratio. It also carried different consumer notification language and put more responsibility upon lenders.

"We're gonna be able to adapt," Keepers said. "The industry is still viable." He said it demonstrated compromise between thesides.

As Keepers noted, some of the new GAP rules could prove moot for service members.

SB 1311 would likely curtail lenders' appetite for bundling and financing GAP within troops' car loans in the traditional way. Based on the bill's wording, such a deal would void the creditor's claim on the vehicle in the event of a default.

Proponents of the measure have argued service members could just buy GAP for cash or finance it in a separate unsecured loan, Keepers said. He called this view unrealistic.

"From a practical perspective ... it's just not gonna happen," he said.

SB 1311 also establishes a GAP military lending policy for California that stands regardless of how the fluctuating issue shakes out at the federal level.

In December 2017, the Defense Department determined "a credit transaction that also finances a credit-related product or service rather than a product or service expressly related to the motor vehicle or personal property" didn't qualify for the auto loan exemption to the Military Lending Act's stricter rules on transactions involving service members. Some dealerships quit offering GAP to troops following the new guidance.

Less than three years later, the Defense Department in February 2020 threw out the 2017 language and reverted to its previous guidance.

But this year, the Pentagon joined the Justice Department and Consumer Financial Protection Bureau to argue in an amicus brief for the GAP class-action lawsuit Davidson v. United Auto Credit that "hybrid loans" containing a vehicle and "a distinct nonexempt product" such as an optional GAP wouldn't be exempt. Oral arguments before the Fourth Circuit Court of Appeals are scheduled for Oct. 26.

Both California GAP bills also come as the Federal Trade Commission considers banning physical accessories and F&I products "that provide no benefit."" The FTC has proposed regulations that define the latter in part as "a GAP Agreement if the consumer's vehicle or neighborhood is excluded from coverage or the loan-to-value ratio would result in the consumer not benefiting financially from the product or service."