What does gap insurance cover and when might you need it

You buy a new car, drive it for six months and then it gets totaled in an accident. Your auto insurance pays for the vehicle, so your car loan disappears too, right?

Not necessarily. That’s where gap insurance comes in.

What is gap insurance?

Guaranteed Asset Protection, commonly called GAP or gap insurance, is optional coverage that helps pay the difference between your remaining auto loan balance and your vehicle’s value if the car is stolen or declared a total loss.

Why might there be a gap? Most new cars lose about 20% of their value during the first year, according to the Insurance Information Institute (Triple-I). If your car depreciates faster than you pay down the loan, that leaves a gap between what the car is worth and what you owe.

What does gap insurance cover?

Gap insurance applies when your vehicle is stolen or totaled and your outstanding loan balance exceeds your primary auto insurance payout.

Here’s how it works:

• You owe $30,000 on your auto loan.
• Your car is worth $25,000 when it’s totaled.
• Your standard auto insurance pays out based on that $25,000 value, subject to your deductible.
• That leaves a $5,000 gap between the car’s value and your loan balance.
• Gap insurance covers that $5,000, depending on your coverage.

Gap insurance isn’t a replacement for standard auto insurance, an extended warranty, or a repair plan. It typically doesn’t cover late or missed payments, lender interest or extended warranties rolled into an auto loan.

Should I get gap insurance?

Gap insurance can make financial sense when there’s a good chance you’ll owe more on your car loan than your vehicle is worth, particularly during the first few years of ownership.

Consider gap insurance if:

• You made a small down payment: Financing more of the vehicle’s purchase price increases the chance your loan balance will initially exceed its value. Triple-I suggests considering gap insurance if you put down less than 20%.
• You have a longer auto loan: Your balance declines more slowly with a longer repayment period. Triple-I suggests considering gap coverage for terms of 60 months or longer.
• Your vehicle depreciates quickly: Faster depreciation can leave you owing more than the car is worth for longer. Check Kelley Blue Book to see how your vehicle may depreciate.
• You rolled negative equity into your new loan: Adding the unpaid balance from a trade-in to your new car loan can leave you owing more than the new vehicle is worth from the start.
• You lease your vehicle: Gap protection is commonly required for leased vehicles, but it may already be included in your lease agreement. Check your paperwork before buying additional coverage.

Do I need gap insurance if I have full coverage?

You may. “Full coverage” generally refers to carrying liability insurance along with collision and comprehensive coverage, but those coverages don’t necessarily pay off your entire car loan after a total loss.

Your auto insurer generally pays based on the vehicle’s value, while your lender expects you to repay what you borrowed. Gap insurance addresses the difference when the second number is higher than the first.

How much does gap insurance cost?

Adding gap insurance coverage to an existing auto insurance policy with collision and comprehensive coverage should only cost about $20 a year to the annual premium, according to Triple-I, but a standalone policy can cost considerably more.

Don’t compare prices alone. Look at what each option covers, any limits or exclusions, and how long the protection lasts.

Pro tip: You likely don’t need gap coverage for the entire length of your loan. Once your loan balance falls below your vehicle’s value, the financial “gap” has disappeared. However, you must typically request the cancellation of coverage with your provider.

How do I know if I have gap insurance?

Before purchasing gap insurance, make sure you don’t already have it.

Check your auto insurance policy, vehicle purchase or lease agreement and financing paperwork for gap coverage or another guaranteed asset protection product. If you’re still unsure, contact your auto insurer or lender and ask whether you currently have coverage, what it covers, and how long it remains in effect.

Where can you buy gap insurance?

Gap insurance coverage may be available through an auto insurance company, lender or dealership. Prices and coverage can vary significantly, so compare your options instead of automatically accepting the coverage offered when you’re buying your vehicle.

Watch for unnecessary add-ons: If you’re offered gap coverage while financing your car, pay particular attention to how you’re paying for it. Rolling the cost into your car loan increases the amount you’re borrowing, which means you’ll also pay interest on the gap coverage over time.

Gap insurance is generally optional. If a dealer or lender says you have to purchase it to qualify for financing, ask where that requirement appears in your contract or confirm the requirement directly with the lender, the Consumer Financial Protection Bureau recommends.

Is gap insurance worth it?

Gap insurance can be worth the added cost if you owe significantly more on your car than it’s worth and paying the difference after a total loss would put a strain on your finances.

Start by comparing your current loan payoff amount with an estimate of your vehicle’s value. If the numbers are close or you owe less than your car is worth, you may not need the additional coverage. If there’s a substantial gap, compare coverage and prices from several sources before buying.