If you have collision or comprehensive coverage, your car insurance company will pay the value of your car in a total loss settlement, not what you owe on a car loan or lease. But if you owe more on your car than what it’s worth, gap insurance can help fill the difference.
“Gap” is an insurance industry acronym for “guaranteed auto protection.” When you buy or lease a new car or truck, the vehicle starts to depreciate in value the moment it leaves the car lot. In fact, most cars lose 20% of their value within a year. Standard auto insurance policies cover the depreciated value of a car — in other words, a standard policy pays the current market value of the vehicle at the time of a claim.
If, when you finance the purchase of a new car and put down only a small deposit, in the early years of the vehicle’s ownership the amount of the loan may exceed the market value of the vehicle itself.
In the event of an accident in which you’ve badly damaged or totaled your car, gap insurance covers the difference between what a vehicle is currently worth (which your standard insurance will pay) and the amount you actually owe on it.
Understanding gap insurance
Gap insurance is a type of auto insurance that you can purchase to protect yourself in case you total your car and the amount of compensation you receive does not fully cover the amount you owe on your financing or lease agreement. It 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 your car is totaled, your car insurance company will reimburse you based on the current value of the car after this depreciation—not the price you paid for it, the cost of a new one, or the amount you still owe on your loan or lease agreement. That’s where gap insurance comes in.
For example, say you bought your car two years ago and owe $20,000 on your financing agreement. However, due to depreciation, your car’s actual cash value is $15,000. If your car is completely written off as a result of an accident or theft, your car insurance policy will pay out $15,000. You can put that $15,000 toward your car loan, but you’ll be $5,000 short of what you owe, even though you no longer have a car.
If you have gap insurance, it would cover the $5,000 “gap,” or the difference between the money you receive from the reimbursement and the amount you still owe on the car.
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.
| Without gap coverage | |
|---|---|
| Total Loan Amount Owed | $20,160 |
| Collision Insurance Payout | $19,600 |
| Shortfall | $-560 |
| (Gap Payout) | (0) |
| Your Out-of-Pocket Cost | $560 |
| With gap coverage | |
|---|---|
| Total Loan Amount Owed | $20,160 |
| Collision Insurance Payout | $19,600 |
| Shortfall | $-560 |
| Gap Payout | $560 |
| Your Out-of-Pocket Cost | $0 |
When to consider gap insurance
- You financed a car and made little or no down payment. Without making a significant down payment, you’ll be upside down in your auto loan the moment you drive off the lot. It may be several years before the loan amount and the car’s actual cash value begin to balance.
- You traded in an upside-down car. When trading in an upside-down car, the dealership will add what you still owe to the loan balance of the new car unless you pay that difference upfront. This extra balance could come back to haunt you if your car is totaled or stolen.
- You plan to put miles on quickly. Very few things reduce a car’s value faster than lots of driving. The faster you rack up the miles, the faster you depreciate your car’s value, and you’ll likely be dropping the value of your car more quickly than your payments can keep pace.
- You took out a car loan with a long term (more than 60 months). A long-term loan takes longer than usual to hit the break-even point, which is when your loan balance and the car’s value begin to equalize.
What does gap insurance cover?
Gap insurance covers the difference between what you owe on a car lease or loan and the amount paid out in a total loss settlement from an auto insurer, minus your deductible. There is only a “gap” to cover if you owe more on your car than it’s worth.
Theft
Yes, gap insurance will pay if your car is stolen.
Engine failure
No. Gap insurance doesn’t cover engine failure. It only pays out after a total loss of your vehicle, such as an auto accident or theft of your car. Mechanical issues on their own are not covered by car insurance or gap insurance.
Transmission failure
No. Gap insurance doesn’t cover transmission failure or any other mechanical repairs.
Death
No. Gap insurance coverage strictly pays out based on the total loss of your vehicle and doesn’t cover injuries, death or funeral costs.
The liability portion of a car insurance policy covers accidental death to others. If you have personal injury protection or medical payments coverage it can cover funeral fees for you and your passengers.
Deductible
No. Gap insurance purchased through a car insurance company usually doesn’t cover your collision or comprehensive deductible amount.
This means if you have a $3,000 gap after your collision insurance pays out and have a $500 collision deductible, gap insurance will pay $2,500. The $500 remaining is the deductible amount.
Some gap insurance policies offered at dealerships will pay your primary insurance policy’s deductible. But be aware that gap insurance purchased from a dealer is typically much more expensive than buying gap coverage from a car insurance company.
Cost of gap insurance
Gap insurance costs an average of $61 a year, according to Forbes Advisor’s analysis.
Gap insurance is much cheaper through a car insurance company compared to a car dealership. Buying gap insurance from a car dealership might seem convenient, but it can often end up costing you more in the long run. Car dealerships typically charge up to $600 for gap insurance that can be added to your loan, according to Trusted Choice, a group of independent insurance agents.
The cost of gap insurance could be rolled into your car loan, but that means you’ll also be paying interest on it. You’ll also lose the flexibility to cancel the gap insurance since it’s tied to your loan, so you might end up paying for something that’s no longer useful.
Cost of gap insurance by company
| Company | Average annual cost of gap insurance |
|---|---|
| Travelers | $34 |
| Progressive | $38 |
| Auto-Owners Insurance | $48 |
| American Family | $51 |
| State Auto | $52 |
| Erie | $58 |
| Shelter | $141 |
| Westfield | $70 |
| Average | $61 |
Do I need gap insurance?
You may consider gap insurance to supplement your collision insurance for the 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.
You may need gap insurance 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 a new loan
In these instances, gap insurance could protect you against potentially negative financial consequences if the vehicle is declared a total loss.
Alternatively, 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.
Pros and cons of gap insurance
| Pros of gap insurance | Cons of gap insurance |
|---|---|
| Covers the insurance gap when you owe more than your vehicle is worth | Extra cost |
| No deductible | If added to a car loan through a dealer, you could pay loan interest on whatever gap costs |
How to get gap insurance
You can generally only add gap insurance to your policy if you still owe money on the vehicle or lease. Although insurers’ guidelines vary, a company may require one or both of the following:
- Your car is no more than two to three years old.
- You are the original owner of the vehicle.
There are two main ways to buy gap insurance:
- From your auto insurer, as part of your regular insurance policy.
- Through the dealership or lender, rolled into your loan payments. With this arrangement, you’re paying interest on the cost of your gap insurance over the life of the loan, making the coverage far more expensive.
If you buy through your dealership or lender:
- Check your auto loan contract to see if you’re required to have gap insurance — not all lenders require it. However, your lender will generally require you to buy comprehensive and collision coverage.
- A dealer may automatically include gap insurance if you lease your car, so make sure to check your lease agreement.
- If you already bought gap insurance from your dealer and want to buy it from your insurer, you may be able to remove it from your car loan contract. Make sure you have coverage during the transition if you switch providers.
Alternatives to gap insurance
Some car insurance companies offer other types of coverage that sound similar to gap insurance. Here are two alternatives to gap insurance that might interest you.
New car replacement coverage
New car replacement coverage reimburses you enough to replace your totaled or stolen vehicle with a new car.
That’s different from the actual cash value, which factors in depreciation. Your vehicle must meet age and mileage requirements to take advantage of new car replacement coverage.
There’s generally a deductible attached to new car replacement coverage.
Here are examples of companies that offer this coverage:
- Amica: Amica’s new car replacement coverage is part of its Platinum Choice Auto package. The new car replacement coverage for Amica replaces a totaled vehicle with a new car if it’s under a year old and has fewer than 15,000 miles on it.
- Farmers: Farmers offer new car replacement coverage for a vehicle of the same make and model if your car gets totaled within the first two model years and 24,000 miles.
- Nationwide: Nationwide provides new car replacements for a vehicle less than three years old.
As you can see new car replacement coverage varies significantly by company, so make sure to read the fine print and understand exactly what you’re getting if you want new car replacement protection.
Better car replacement coverage
Some car insurance companies, such as Horace Mann and Liberty Mutual, offer “better car replacement” coverage. This reimburses you for a newer or better model of your totaled car. This coverage may also have mileage parameters. For example, Liberty Mutual will reimburse you for a vehicle that’s one model year newer and with 15,000 fewer miles than the vehicle that was totaled.
The optional coverage is only for policyholders who own their cars. It’s not available for leased cars.
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