Auto Insurance

What Is Gap Insurance?

A gap policy pays out in the event of a total loss when you owe more than what your vehicle is worth. Learn how gap coverage works, who should consider the coverage, how to get the best price, and how and when to cancel the gap coverage.

Whats Gap Insurance

Gap coverage is an insurance that kicks in to pay the difference between the auto loan you still owe and the depreciated price of the car if your vehicle is totaled. It can be a critical coverage for those taking out a substantial auto loan because at the rapid rate in which cars depreciate in value, if your car is considered a total loss, you may end up owing more in loans than what your insurance company will pay for the loss.

How Does Gap Insurance Work?

A gap policy would pay the difference between what your standard auto insurance policy covers and what is still owed on your vehicle’s loan. The average car loses approximately 20% of its value within the first 5 years of its life and continues to depreciate until it’s worth as close to $0 as possible.

In the event of a total loss, such as when the damage to a car is so severe that it is unrepairable, the insurance company will only pay what the car was worth at the time of the loss. Ideally, your monthly payments should stay even or exceed the depreciation of the car. If that were the case, the check from the insurance company would be able to pay off the remainder of your car loan without you having to pay anything out of pocket. 

However, if you have been making smaller payments due to leasing or financing for longer periods, it is likely that your payments will fall behind your car’s depreciation schedule. If the vehicle was then totaled in an accident while you’re behind the depreciated value of the vehicle, there would be a balance left over that you would have to pay out of pocket to pay off the loan completely.

Gap vs. Standard Car Insurance

Gap coverage goes hand in hand with comprehensive and collision coverage, but it is not the same.

While comprehensive and collision coverage will pay for the damages done to your vehicle when it has been totaled, it will only pay up to the current value of your car according to how much it has depreciated. For example, even if you purchased a car for $50,000, it may be worth $37,000 at the time it is totaled because of value depreciation over time. This means your standard car insurance policy would only pay up to $37,000 to replace the vehicle.

However, if you took out a loan to cover the purchase of your car, you may owe more than $37,000 for it at the time of the accident. In this case, even after your standard auto insurance policy pays to replace your car, you still owe money towards the initial loan. For example, if your auto loan balance still has $45,000 left on it and your comprehensive and collision coverage pays you $37,000 to replace your vehicle, you would still owe $8,000 in loans for the totaled vehicle.

This is where gap insurance would kick in and cover that last $8,000 so you will not have to pay that out of pocket.

Gap vs. Umbrella Car Insurance

While gap insurance pays for the difference between what your standard auto insurance policy will pay to replace your vehicle and the amount you still owe for the loan on that vehicle, umbrella insurance is only concerned with extending the liability coverage of your car insurance policy.

Liability coverage is how much a car insurance policy will pay out for damages done to another driver, their vehicle, and their property if you are at fault in a collision. All car insurance policies have maximum limits that cap how much it will pay. For example, your standard car insurance may have a limit of $300,000 per incident for liability coverage. An umbrella policy would extend that coverage limit by an amount you set, such as by adding an additional $250,000 worth of coverage.

This means if you are at fault in a collision and the damages add up to $550,000, your standard car insurance policy would cover the maximum of $300,000 and your umbrella policy would cover the remaining $250,000 based on its maximum limit. Without an umbrella policy, the remaining $250,000 would have to come out of pocket.

What Does Gap Insurance Cover?

Gap coverage kicks in after your standard car insurance takes care of valuing your car — it covers the financial “gap” between the actual cash value of your vehicle and what you still owe on your loan. If your vehicle is totaled in an accident, the insurance company will send a check for what your car was worth at the time of the accident. If there’s still a balance left to be paid after issuing the payment to the lender, gap coverage would pay the balance to the lender so you wouldn’t have to pay out of pocket. 

What Does Gap Insurance Not Cover?

Gap insurance does not cover the policy holder’s or the other person’s medical care due to an accident. Nor does it pay any repair cost or fees to have your or anyone else’s vehicles fixed after an accident, vandalism, theft, or anything else that would result in a policy holder’s vehicle being a total loss.

Who Should Consider Gap Insurance?

Those who fit the following criteria should consider gap coverage while purchasing or leasing a vehicle:

  • Anyone who plans to lease or finance a car with less than 20% down and longer than 60 months. The first 60 months of the loan or lease period are the most critical months because the average car depreciates the most at the very beginning of its life on the road. Your payments will be smaller the longer you finance the vehicle, so the difference between the loan balance and the actual cash value for the vehicle can be significant during this time of your loan period. 
  • Anyone financing or leasing a vehicle that depreciates quickly. This can include vehicles such as sports cars, high-end vehicles, and certain electric cars.
  • Anyone who purchases or includes add-ons with their loan. This can include debt from other car loans or extended service agreements. Products of that nature increase your loan amount without adding any value to the vehicle.

How Much Does Gap Coverage Cost?

The price for gap coverage depends on several factors: 

  • The actual cash value of the vehicle 
  • The vehicle age
  • The potential policy holder’s auto insurance claims history 
  • The potential policy holder’s auto insurance location
  • Who is offering the coverage

Auto dealerships and lenders are typically the more expensive option when it comes to purchasing gap coverage. They often offer the coverage for a flat rate between $500 and $700, which is then rolled into your car loan. That means the policyholder will pay interest on the additional coverage as opposed to paying for it outright. Going through the insurance company is typically the most cost-effective option. Certain insurance companies will offer gap insurance coverage for $20 to $40 per year when added to other insurance services. 

How to Get Gap Insurance

In most cases, the car dealership where you are purchasing your vehicle will offer gap coverage as you’re going over the final paperwork. Gap coverage is also available through lenders or other banks and credit unions that are financing the vehicle, and some financiers will require it before you can leave the lot with the car.

You can also reach out to your insurance company to ask about gap coverage when considering leasing or purchasing a vehicle so you’ll have a frame of reference while considering the cost of the policy. Certain insurance companies offer gap protection, but may call it loan or lease gap coverage. If you choose to go through an insurance company for the coverage, such as your car insurance company, make sure you understand how gap insurance works with their policies as the details may differ by insurer. 

Things to Consider With Gap Insurance

A few things to keep in mind while considering gap coverage are: 

  • What happens with the coverage if you sell the car before the life of the policy has run its course?In some cases, the provider will refund the unused portion of the coverage after the sale of the vehicle. 
  • Can you add gap coverage to your vehicle after the paperwork is signed? Some dealerships and insurance companies will allow you to add gap coverage after you purchase the car.
  • Can you use gap insurance on a used vehicle? Some insurers have restrictions on adding gap coverage to a used vehicle, even if you buy it from a dealership. Check with your insurer if you are purchasing a used vehicle and would like gap coverage to protect yourself.

How and When to Cancel Gap Coverage

Gap insurance is only necessary during the period of your loan or lease when the difference between the actual cash value of the vehicle is less than the loan amount, or when the vehicle is depreciating faster than you’re paying it off. Check websites like Kelly Blue Book or the National Automobile Dealers Association to look up your car’s value against the balance owed on your loan so you’ll know when the loan amount falls below the actual cash value of the vehicle. Once this happens, reach out to your coverage provider to cancel the gap coverage. They’ll let you know if any additional steps are required to cancel at that time, such as additional paperwork you may need to sign to confirm cancelation.