What to know if you’re financing or leasing a car
“Gap” is an insurance industry acronym for “guaranteed auto protection.” This type of insurance is only needed for a short period of time while the value of a loan taken out to buy a car is greater than the overall value of the car. With gap insurance, the insurer would be liable to repay this difference in value should the car get totaled in an accident. Normal car insurance won’t cover this.
For example, if you put no money down when you financed or leased a car, then the amount that you’ve borrowed may be more than the total cost of the car for a few years. If the car is totaled in an accident or stolen, standard car insurance will only pay you the current value, so you’ll lose money paying back the original loan or lease. Gap insurance covers this “gap” between the depreciated value of the car and the amount owed on the loan.
Whether you need car gap insurance can depend on the type of vehicle that you purchase or lease. But is gap insurance worth it? It may be if you believe you may owe more money on a vehicle than your comprehensive auto insurance policy would pay out if you were to file a claim.
KEY TAKEAWAYS
- Gap insurance—also known as guaranteed auto protection—reimburses a car owner when the payment for a total loss is less than the outstanding loan or lease balance.
- Gap insurance is only needed for a short period of time while the loan value is greater than the overall value of the car being leased or financed. With gap insurance, the insurer would be liable to repay this difference in value should the car get totaled in an accident. Normal car insurance won’t cover this.
- Gap insurance makes the most sense for people who put no money down and choose a long payoff period. For a couple of years, they may owe more on the car than its current value.
- It also makes sense for those who lease rather than purchase a vehicle.
- You may be able to skip gap insurance if you made a down payment of at least 20% on the car when you bought it, or if you’re paying off the car loan in less than five years.
- You don’t need gap insurance for the life of the car, just until your loan balance doesn’t exceed the car’s value.
What Is Gap Insurance on a Car?
Gap insurance is a supplemental auto policy that covers any difference between the insured value of a vehicle and the balance of the loan or lease that the owner must repay. If your vehicle is totaled or stolen before the loan on it is paid off, then gap insurance is needed to cover any difference between your auto insurance payout and the amount that you owe on the vehicle.1
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 than usual, such as luxury sedans or SUVs or certain other types of SUVs.
Some dealers offer gap insurance when you purchase or lease a vehicle. However, it’s important to compare the cost to what traditional insurers may charge.
How Gap Insurance Works
It’s fairly easy for a driver to owe the lender or leasing company more than the car is worth in its early years. A small down payment and a long loan or lease period are enough to do it, at least until your monthly payments add up to sufficient equity in the vehicle.
In terms of filing claims and vehicle valuations, equity must equal the current value of the car. That value, not the price you paid, is what your regular insurance will pay if the car is wrecked. The problem is that cars depreciate quickly during their first couple of years on the road. In fact, the average automobile loses 10% of its value in just the first month after purchasing it.2
If your vehicle is wrecked, your policy won’t pay the cost of replacing the car with a brand-new vehicle. You’ll get a check for what a car comparable to yours would sell for on a used-car lot. Insurers call this the vehicle’s actual cash value.
Gap insurance doesn’t cover that particular gap. The payouts are based on actual cash value, not replacement value, which can help to minimize financial losses to you.
Car Gap Insurance Example
Say you purchased a new car with a sticker price of $28,000. You paid 10% down, bringing your loan cost down to $25,200. You got a five-year auto loan. For the sake of simplicity, let’s say you scored one of those 0 percent new-car financing deals, so your monthly payment is $420. After 12 months, you’ve paid $5,040. You still owe $20,160.
One year later, the car is wrecked and the insurance company writes it off as a total loss. According to your auto insurance policy, you are owed the full current value of that vehicle. Like the average car, your car is now worth 20% less than you paid for it a year ago. That’s $22,400.
Your collision 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? For instance, say it’s depreciated by 30% since you purchased it. In that case, your insurance check will be $19,600. You owe your lender $560. And you still need a new car, which is where having car gap insurance becomes important.
Do You Need Gap Insurance?
You may have heard the term “upside down” in reference to a home mortgage debt. The concept is the same whether the item financed is a house or a car: The thing financed is currently worth less than the balance of the loan taken out to acquire it.
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 down the principal, your ownership share expands and your debt shrinks.
Gap insurance is needed to cover the shortfall, so you’re not on the hook if the car is wrecked.
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 loan3
In these instances, gap insurance could protect you against potentially negative financial consequences if the vehicle were to be declared a total loss.
If you have purchased gap insurance, check your loan balance from time to time and cancel the insurance once you owe less than the book value of your vehicle.
You May Be Able to Skip Gap Insurance If…
If you’re still paying off your car, you almost certainly need collision coverage. You’d be playing with fire without it, and, in any case, 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 get an idea of how much your car is worth. Compare it to your loan balance. If your loan balance is less than your car’s value, then you no longer have a gap to worry about.
Replacement Value Insurance vs. Gap Insurance
Replacement value insurance, also sometimes called new car replacement insurance, is a policy feature offered by some 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 an effective replacement for gap insurance.
Generally, your car must meet age and mileage requirements to qualify for this type of insurance. Also, it’s normally only available if you purchase collision and comprehensive coverage. If you qualify, however, this type of policy can completely replace gap insurance.
Pros and Cons of Car Gap Insurance
Buying a new car is an expensive proposition these days. The average new car loan is in excess of $32,000. The average loan term is now 70 months.4
You wouldn’t dream of skipping collision insurance on that car, even if your lender allowed you to do it. But 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. That is what your collision insurance policy will pay out if the car is wrecked.
This is most commonly the case in the first few years of ownership if you put down less than 20% on the car and stretched the loan repayment term to five years or more. A quick look at a Kelley Blue Book will tell you whether you need gap insurance. Is your car currently worth less than the balance on the loan? If so, you need gap insurance.
Is gap insurance needed?
If there is any time during which you owe more on your car than it is currently worth, gap insurance can definitely be worth the money.
If you put down less than 20% on a car, you’re wise to get gap insurance at least for the first couple of years that you own it. By then, you should owe less on the car than it is worth. If the car is wrecked, you won’t have to pay out of pocket to make up the shortfall between the insured value of the car and the amount that you owe a lender.
Gap insurance is particularly worth it if you take advantage of a dealer’s periodic car-buying incentive. If you’re getting a deal for a low down payment and three months “free,” you are surely going to be upside down on that loan for many months to come.
Do you need car gap insurance if you have full coverage?
Comprehensive auto insurance is full coverage. It includes collision insurance but also covers every unexpected calamity that can destroy a car, from vandalism to a flood. But it pays the actual cash value of the car, not the price you paid for it or the amount you may still owe on the loan. Gap insurance covers the difference.
Therefore, you need gap insurance if there is indeed a gap between what you owe and what the car is worth on a used-car lot. That is most likely to occur in the first couple of years of ownership, while your new car is depreciating faster than your loan balance is shrinking. You can cancel the gap insurance once your loan balance is low enough to be covered in full by a collision insurance payment.
What does gap insurance do?
Think of it as a supplemental insurance policy for your car loan. If your car is wrecked, and your comprehensive auto insurance policy pays less than you owe the lender, then the gap policy will make up the difference.
How do I get gap insurance?
The easiest—and probably the cheapest—way is to ask your auto insurance company if they can add it to your existing policy. You can compare prices online to make sure that you’re getting the best deal.
The car dealership will probably offer you a gap policy, but the price almost certainly will be higher than a major insurer will offer. In any case, check to make sure that you don’t already have gap insurance on your vehicle. Auto lease deals often build gap coverage into their pricing.
Do you need gap insurance after you buy a car?
Sometimes. Your best bet is to call your auto insurance company and ask whether you can add it to your existing policy. Your insurer should be able to tell you what your options are and how much adding gap coverage may cost. Be sure to compare the best car insurance rates to find the right option.
The Bottom Line
Gap insurance is typically an optional insurance product unless it’s required by the terms of your lease or loan agreement. Nevertheless, it could give you considerable peace of mind if you recently shelled out for a new car.
Specifically, car gap insurance is sensible for those with significant negative equity in a car. That includes drivers who put little money down or have a protracted loan payoff period. If you’re interested in cutting your car insurance costs, not paying for gap insurance once you don’t really need it is one way to save some money.