Gap insurance covers the gap between what your car is worth and what you still owe on it.
Gap insurance is a type of car insurance that pays for the “gap” between what you still owe on a lease or loan and what the auto insurance company paid out when your car is stolen or destroyed in a total loss. Gap is a backronym for “guaranteed auto protection.”
You may be required to add gap insurance to your car insurance policy by your creditor or lienholder. However, if you’re not required to have gap insurance, it may still be a good way to recoup as much as you can from a loss, especially if you’re “under water” on your loan.
Gap insurance is relatively inexpensive to add. Take what you already pay for collision and comprehensive insurance and add another 5%.
Read on to learn more about gap insurance:
The second you drive your new car off the lot, the car starts depreciating in value. If you leased your car or financed your car with an auto loan, the car will be worth slightly less than your combined lease payments or the principal balance on your loan.
That means if the vehicle gets destroyed in an accident or some other type of hazard, or gets stolen and isn’t recovered, your car insurance may only pay the actual cash value (ACV) of the car – what you paid for it minus depreciation. When the ACV is less than the amount you still owe on the lease or loan, you’ll continue to owe money to the lienholder or creditor for a car you no longer have in your possession. Another term for this is “negative equity.”
For example, say you bought a new car for $30,000, including taxes and fees, and you put $1,000 down. About a year later, you get in an accident and your car is totaled. You file a claim with your insurance provider through your policy’s collision insurance and find out your car is valued at $22,000, its depreciated value at the time of the loss. Meanwhile, you owe $25,000 after a year’s worth of payments, which leaves you with a $3,000 "gap." If you have gap insurance, you’ll receive a payout from the car insurance company for that remaining $3,000 in addition to the $22,000 it owes you.
Before you decide whether you need gap insurance, look at how much you’re spending each month to pay off your car loan. If the vehicle depreciates at a slower rate than your payments reduce your loan principal, then you probably don’t need gap coverage.
Your lienholder or creditor may require you to purchase gap insurance as part of the financing agreement when you lease your car or purchase it with an auto loan.
If you’re not required to purchase gap insurance, there are a number of reasons why you should consider adding gap insurance.
Also known as being “under water” or “upside-down,” this can happen if you’ve missed payments, if your payments are too small to outstrip the pace of depreciation, or if your car is simply too new.
If you put less than 20% down on your new car and take out a loan for more than four years, you will commonly owe more on your car than its current value, at least for the first two years of your loan.
With long-term financing, you’re allowed to make lower payments because they’re spread out over a longer period of time. While this means you’ll be able to afford the car sooner, it could also certainly ensures that your car will depreciate faster than your payments can make up for.
In the event that your car is totaled or stolen, you may not have the funds to keep paying the financial institution that extended you your loan.
Driving an excessive amount means your car will depreciate in value more rapidly than similar cars not driven as much.
Some cars hold up their value better than others, so it would be worth researching the rate of depreciation of your car. Higher-end cars may be especially susceptible to increased depreciation because they’re prized for their newness and sheen.
Since your comprehensive insurance covers theft, you probably already have it for your popular car. Gap insurance extends your comp coverage to value of the car before depreciation.
Gap insurance is an enhancement to your property damage coverage; namely, the collision and comprehensive insurance that fall under your overall car insurance coverage. Collision insurance covers damage to your car from an accident with another car; comprehensive covers damage to your car from other perils, like some kinds of weather or malicious human activity. In the event of a total loss, those two types of car insurance will pay up to the ACV of the car, and gap insurance will pay the rest.
A licensed representative at Policygenius can make it easy to find you an auto insurance policy with collision, comp, and gap insurance at an affordable price.
Occasionally, some car insurers may limit the amount of “gap” they will pay off. For example, say your insurer’s maximum for gap coverage is 25% over the ACV. If you bought the car at $20,000, and it has depreciated to $10,000, you’ll only be eligible for $12,500 in reimbursement minus the deductible after a total loss.
When purchasing gap insurance, make sure you talk to the carrier to confirm that you’re getting the amount of coverage you need. Your insurer may offer a higher limit in return for a higher premium, but what every insurer offers, and in which states, is different.
Because gap insurance specifically covers the physical loss of your vehicle, it doesn’t cover expenses like medical bills or liability to others. Those coverages are extended by the other components of car insurance in your policy.
Gap insurance does not cover any type of bodily injury.
Your bodily injury liability coverage pays the medical expenses of someone you injure in a car accident. It will also pay for funeral expenses if the person you hit dies.
If you have personal injury protection (PIP) or MedPay coverage, those types of car insurance will pay your medical bills or those of your passengers when nobody is at fault in the accident.
This is covered under your property liability insurance. Your gap insurance won’t cover the difference between how much somebody else owes on their own property.
Mechanical repairs, such as engine failure, are not covered by gap insurance. Gap insurance only covers the difference between how much you owe on a car loan if the car is gone forever.
Collision and comprehensive insurance have a deductible, which is the amount you have to pay out of pocket on a given claim before the rest of the claim is paid for the insurer. Gap insurance doesn’t have a deductible itself, but it will not pay the deductible you owe for your collision and comp coverage.
Say you get into a pretty devastating accident. Your car insurance pays for the repairs and you’re able to drive the car again. While the accident may depreciate the car even further and cause your negative equity to increase, your gap insurance doesn’t come into play unless the car is completely totaled.
Adding gap insurance costs an additional 5% of your total comprehensive and collision bill per year.
Collision and comprehensive insurance comprise approximately 60% to 70% of your premium. If you pay $1,000 per year for car insurance, $700 of that may be going toward your collision and comprehensive insurance. In this example, adding gap insurance would be an additional $35 per year, for a total premium of $1,035. (If $700 for property damage coverage seems like a lot, consider raising your deductible, which may lower your premiums but leave you open to more risk if your car is damaged.)
Gap insurance might be a considerably higher if purchased through your dealership, so be sure to check the price from the auto insurer through which you already have coverage. Going this route also makes the claims process easier.
Zack Sigel is a SEO managing editor at Policygenius. He covers personal finance, comprising mortgages, investing, deposit accounts, and more. His previous work included writing about film and music.