Gap insurance pays the difference between the balance of a lease or loan on a car and what the vehicle is actually worth if it is declared a total loss. Gap insurance, which stands for guaranteed asset protection, pays off the remaining balance owed so that you don't have to make payments on a car that is no longer drivable.
Gap coverage usually only applies when a driver has comprehensive and collision insurance. Collision or comprehensive coverage will pay out the car’s value if it’s a total loss, and then gap insurance fills in the rest.
What Does Gap Insurance Cover?
Gap insurance ultimately covers depreciation, which is important because new cars quickly lose their value. Cars have different resale values, so depreciation varies by vehicle. But on average, a car loses about 11% of its value on the first day alone, and about 20% - 30% of its value within the first year.
A car’s depreciation rate, as well as the loan/lease balance and interest rate, will affect the gap between how much a driver owes on the car and the amount the car is actually worth. When there’s a difference between these two numbers, gap insurance covers that difference. Owing more than the car is worth is called being “underwater” or “upside down” on your loan.
Gap Insurance Example
Imagine you buy a $50,000 car with a down payment of $10,000. Three years later, the car is worth $20,000, but you still owe $24,000 on the loan. If the car is totaled in an accident or stolen and declared a total loss, your normal insurance policy will pay $20,000, or the car’s actual cash value (ACV), minus your deductible.
If you don’t have gap insurance, you’ll still owe $4,000, and you’ll still have to pay off the car even though you can’t drive it. But if you do have gap insurance, it will pay the $4,000. Some gap insurance policies even pay your deductible, though most do not.
What Gap Insurance Does Not Cover
- Medical bills for you or another driver
- Damage to another driver’s property
- The cost of repairing or replacing your vehicle
- Car payments missed due to personal circumstances like an injury or job loss
- Reduced value after an accident that does not total the car
- Engine failure or a mechanical problem
It’s also important to keep in mind that the money you receive from gap insurance will go to your lender or lessor, not toward your purchase of a new car. If you’re interested in coverage that will help you buy a car in the future, look into new car replacement insurance instead.
Finally, you can buy gap insurance from a dealership, bank, credit union, or car insurance company. It’s not legally mandated in any state, though car dealerships will sometimes require it on a leased or financed vehicle. If you sell a car, pay it off early, or trade it in, you can usually receive a gap insurance refund.
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