Gap insurance is a type of car insurance that covers the “gap” between what a car is worth and what the driver owes on their auto loan or lease if the car is totaled or stolen. Without gap insurance, drivers can be stuck paying the remaining loan or lease balance on a vehicle that they can no longer drive.
Key Things to Know About Gap Insurance
- Gap insurance pays for the difference between what a totaled car is worth and what the driver still owes on their auto loan or lease.
- Drivers should consider getting gap insurance if they made a small loan down payment, lease their car, or have a car that depreciates quickly.
- You can get gap insurance from your car insurance company, loan provider, or dealership.
- Gap insurance costs between $400 and $700 when purchased from a dealership and between $20 and $40 per year when added to a car insurance policy.
How Gap Insurance Works
Gap insurance covers the dollar-amount “gap” between what a car is worth and what is owed on the loan or lease, in the event of a vehicle-totaling accident or theft. If a buyer or lessee were to suffer a total loss without gap insurance, standard insurance would only cover the actual cash value of the car, leaving the driver potentially owing thousands of dollars to the lender.
A gap forms as a result of a car depreciating faster than the loan or lease amount can be paid off. A new car loses about 10 percent of its value the moment you drive it off the lot, and it depreciates by about 20 percent within the first year, according to Edmunds.
For example, let’s say you buy a new Honda Accord for $27,000. The day it’s purchased, the car’s “actual cash value” (ACV) falls to approximately $24,300. One year later the actual cash value might be approximately $21,600. With that depreciation in mind, let’s take a closer look at how gap insurance works with this new Honda Accord driver.
|New Honda Accord||$27,000|
|Balance after one year (4 percent interest/five-year loan)||$23,868|
|Actual cash value after one year||$21,600|
|Insurance payment without gap coverage||$21,100|
|Gap insurance payment||$2,768|
In other words, gap insurance coverage would pay all of the nearly $3,000 deficit in this scenario. Depending on the details of your policy, it may also cover the $500 deductible.
In summary, gap coverage works alongside liability, collision and comprehensive insurance to protect car owners with negative equity. It can also pay deductibles, within a limit. Check to make sure your collision and comprehensive deductibles aren’t greater than what your gap policy will cover.
Who Needs Gap Insurance?
If You Made a Zero or Low Down Payment On Your Loan
Making a down payment helps close the gap between what you owe and the car’s depreciated value.
If You Lease Your Car
Auto leases have lower monthly payments than loans because the buyer pays much less principal every month. Many include gap coverage automatically.
If Your Car Depreciates Quickly
If You Roll Other Products Into Your Auto Financing
Financing extended service agreements, dealer-installed options or debt from previous auto financing increases what you owe without necessarily increasing the value of your car.
If Your Car Has High Mileage
Driving more than 15,000 miles per year speeds up your car’s depreciation.
It’s also worth noting that the average car loan today has a 72-month term, according to Experian Automotive. That’s important because the more time it takes to pay off a loan, the longer it takes for loan payments to catch up with the car’s depreciating value. In other words, long-term loans almost guarantee that the car buyer will have negative equity for some period of time, creating the need for gap insurance.
How To Get Gap Insurance
You can purchase gap insurance from many car dealers, although these policies are usually quite expensive. Gap coverage may also be available from your lender, and its cost will be included in the total amount you finance you finance with the loan.
The easiest way to buy gap insurance coverage is through an insurance company. If your current insurance company offers gap insurance, you can add it to your existing policy. Keep in mind, however, that if your insurer doesn’t offer gap insurance, then you cannot buy it as a standalone policy from another car insurance company.
Insurance Companies That Offer Gap Insurance
Leases commonly include gap coverage or waiver of “gap liability.” So if you have leased a car, you might be covered already. Be sure to read your lease terms carefully to avoid purchasing additional gap coverage you don’t need.
Gap Insurance Cost
The cost of gap insurance varies depending on where you buy it. Dealerships and banks charge a lump sum of up to $700 for gap insurance, making them the most expensive choice. Since the sum is usually added to your auto loan, you will have to pay interest on it, too.
The best deals on gap insurance are generally available from car insurance companies, which charge as little as $5 per month for coverage. Instead of charging a lump sum, insurers include the cost in your regular premium payments.
If you sell your car before paying off the loan and you paid for gap insurance up front, you are often entitled to a refund for the portion of the insurance you didn’t use. If you’re paying monthly for a gap policy, keep track of what your car is worth using Kelley Blue Book or NADA Guides. Once you owe less than the car is worth, it’s safe to cancel any gap coverage.
Is Gap Insurance Worth It?
If you purchase a new car with zero or low down payment financing, or if your car loan extends for five or more years, you definitely should understand your exposure and weigh the cost of gap coverage.
Don’t assume you have to buy gap insurance from the dealer; be sure to check into the options available from your lender and your auto insurance company. If you bought coverage from the dealer, it might not be too late to shop elsewhere. It is likely you can cancel it and get cheaper coverage elsewhere. You can then go back to the dealer for a refund of any prepaid coverage you didn’t use.
If you shop around, you are likely to find gap insurance is an affordable way to protect you from the risk of a big expense in the event your car is totaled or stolen.
If you don’t purchase this coverage and find yourself facing a remaining loan balance after an accident, all is not lost. Through a “collateral exchange,” you may be able to roll the balance of your old loan into a new auto loan or lease when you buy a replacement car.
Ask the Experts
To gain more insight about Gap insurance, WalletHub posed the following questions to a panel of experts. Click on the experts below to view their bios and answers.
1. Who should purchase gap insurance?
2. Is it better to buy gap insurance through a dealership, lender, or car insurance company?
3. When should drivers drop gap insurance coverage?
4. What should drivers look for in a gap insurance policy?
5. Can drivers actually save as much as insurance companies advertise when switching companies?
6. Why do car insurance companies spend so much on commercials?
7. Should drivers trust their insurance company?