Do You Need Gap Insurance?

“Gap” is an insurance industry acronym for “guaranteed auto protection.” Gap insurance reimburses a car owner when the payment for a total loss is less than the outstanding loan or lease balance. Gap insurance covers the difference between the depreciated value of the car and the loan amount owed if the car is involved in an accident.

If you finance or lease a car without a down payment, then the amount you’ve borrowed may be more than the total value of the car. If the car is totaled in an accident or stolen, standard car insurance will only pay up to the current value, which may be less than the outstanding loan or lease amount.

What Is Gap Insurance on a Car?

Gap insurance is a supplemental auto policy that covers any difference between the insured current value of a vehicle and the balance of a loan or lease. If a vehicle is totaled or stolen before the loan is paid, gap insurance covers the difference between the auto insurance payout and the loan amount owed on the vehicle.

If you’re financing a vehicle purchase, your lender may require you to have gap insurance for certain types of cars, trucks, or SUVs. Specifically, this includes vehicles that may depreciate and lose value at faster rates, such as luxury sedans or SUVs.

How Gap Insurance Works

It’s easy for a driver to owe the lender or leasing company more than the car is worth. A small down payment and a long loan or lease period delay equity in the vehicle. The current value of the car, not the price you paid, is what your regular insurance will pay if the car is totaled. However, cars depreciate quickly. The average automobile loses 10% of its value in the first month after purchasing it.

Your policy won’t pay the cost of replacing the car with a brand-new vehicle. You’ll be reimbursed for what a car comparable to yours would sell for on a used-car lot. Insurers call this the vehicle’s actual cash value. Since payouts are based on actual cash value, not replacement value, gap insurance can help to minimize your financial losses.

Gap Insurance Example

You purchased a new car with a sticker price of $28,000 with 10% down, bringing your loan cost to $25,200. With a five-year auto loan and a 0 percent new-car financing deal, your monthly payment is $420. After 12 months, you’ve paid $5,040. You still owe $20,160.

At one year, the car is totaled in an accident, and the insurance company calculates the current value of the vehicle. Like the average car, your car is now worth 20% less than you paid a year ago. That’s $22,400. Your coverage will reimburse you enough to cover the outstanding balance on your car loan and leave you $2,240 to put down on a replacement vehicle.

But what if your car was one of the models that don’t hold their value as well? If your car depreciated by 30% since you purchased it, your insurance check will be $19,600. You owe your lender $560, and gap insurance is needed.

Do You Need Gap Insurance?

In 2022, the average new car loan exceeded $32,000 with an average loan term of 70 months.You may consider gap insurance to supplement your collision insurance for the period of time when you owe more for that car than its actual cash value.

You may have heard the term “upside down” about a home mortgage debt. The concept is the same whether the item financed is a house or a car. It may currently be worth less than the loan balance.

This isn’t as dire as it sounds. If you put only a little money down on a purchase and pay the rest in small monthly installments spread over five years or more, you don’t immediately own much of that house or car free and clear. As you pay the principal, your ownership share expands, and your debt shrinks.

Car Gap Insurance May Make Sense If...

According to the Insurance Information Institute, you may need to consider buying gap insurance for your new car or truck purchase if you:

• Made less than a 20% down payment
• Financed for 60 months or longer
• Leased the vehicle (carrying gap insurance is generally required for a lease)
• Purchased a vehicle that depreciates faster than the average
• Rolled over negative equity from an old car loan into the new loan

In these instances, gap insurance could protect you against potentially negative financial consequences if the vehicle is declared a total loss.

You May Be Able to Skip Gap Insurance If...

If you’re still paying off your car, you need collision coverage. You’re probably required to have collision coverage by the terms of your loan or lease agreement.

• You made a down payment of at least 20% on the car when you bought it, so there’s little chance that you will be upside down on your loan, even in the first year or so that you own it.
• You’re paying off the car loan in less than five years.
• The vehicle is a make and model that historically holds its value better than average.

It’s worth checking the National Automobile Dealers Association (NADA) guide or Kelley Blue Book periodically to see how much your car is worth. Compare it to your loan balance. If your loan balance is less than the car’s value, you no longer have a gap to worry about.

Replacement Value Insurance vs. Gap Insurance

Replacement value insurance, sometimes called new car replacement insurance, is a policy feature offered by car insurance companies. This option gives you money for a brand-new car of the same make and model (minus your deductible) instead of the depreciated value of your totaled car if your vehicle gets totaled. This type of insurance can be a replacement for gap insurance. Your car must meet age and mileage requirements to qualify for this type of insurance.

Gap Insurance Cost

Gap insurance can be added to your comprehensive auto insurance policy for as little as $20 a year, according to the Insurance Information Institute.Your cost will vary according to the laws of insurance. Your state, age, driving record and vehicle affect pricing.

An insurer typically prices it at 5% to 6% of the collision and comprehensive premiums on your auto insurance policy. For example, if you pay $1,000 a year combined for those two coverages, gap insurance may add $50 to $60 extra. An insurer for gap coverage is usually cheaper than a dealer or a lender, according to Bankrate.

Some dealers are required by state law to offer gap insurance. Dealers typically charge substantially more than the major insurance companies. On average, a dealership will charge you a flat rate of $500 to $700 for a gap policy. Many insurers will allow you to add gap insurance to your existing auto insurance policy.

The Bottom Line

Gap insurance is an optional product sometimes required by the terms of your lease or loan agreement. A gap insurance policy makes sense for those with significant negative equity in a car. That includes drivers who put little money down or have a protracted loan payoff period.

Correction—April 26, 2023: This article has been amended to correctly define gap insurance as needed for any period when the current value of a vehicle is less than the balance of a loan or lease.