What Is Gap Insurance?

Vehicle with a shield illustration illustration by Paul Dolan

If your car is stolen or totaled in an accident, gap insurance covers the difference (the “gap”) between what you owe on a loan or lease and what the vehicle is worth, or what the insurance industry calls the actual cash value. Also known as guaranteed auto protection, gap insurance is typically optional but may be required by some lenders, and it is included in some leases. So, do you need it? 

Related: How Do I Trade In a Car That Has Negative Equity?

The main reason to have gap insurance is because cars depreciate rapidly in the first few years, roughly 20% the first year and 40% or more after three years. If someone makes a small down payment on a loan or signs a lease that requires only a minimal upfront payment, that rapid depreciation means during the first few years of ownership they could owe more than the actual cash value if the vehicle gets totaled or is not recovered from a theft.

Who Needs It?

Here’s an example: if a vehicle is totaled and the insurer determines that the actual cash value is $25,000, but the owner still owes $28,000, the owner would have to cover that $3,000 difference if they didn’t have gap insurance. 

The average new-vehicle loan is for nearly six years, and a purchaser can “be upside down” (owe more than the car is worth) for three or four years or longer, especially if they rolled negative equity from a previous vehicle into their loan.

Everyone, though, may not need gap insurance. For example, making a down payment of at least 20% or keeping the loan to five years or less might mean the car is always worth more than what is owed on a loan.

Gap insurance might be advisable at the time of purchase but not necessary over the life of a loan. The buyer may be underwater for only a couple of years before the monthly payments on the loan principal catch up to the depreciation on a vehicle that holds its value well. Conversely, they could be underwater longer on a vehicle that loses value quickly.

Dealerships Vs. Insurance Companies

The value estimator, lenders and insurance companies can estimate a car’s value based on its age, mileage and condition to help determine if gap insurance is still necessary based on how much the owner still owes.

Car dealers offer gap insurance, often for a flat fee that can be hundreds of dollars, but the Insurance Information Institute says insurance companies can add it to a collision and comprehensive policy for as little as $20 to $40 per year. As with other insurance coverage, the amount can be higher based on the value of the vehicle as well as the age and driving record of the owner.

Insurance companies write their own rules for gap coverage, and some require that you pay the usual deductible on collision and comprehensive coverage; others don’t. Before agreeing to buy gap insurance, it is best to check costs from more than one source, such as an insurance company or a dealer, and get a second opinion on whether it’s necessary. On a lease, ask before signing to see if it’s included to make sure you don’t pay for something you already have.

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