Everything You Need to Know About Gap Insurance

In the event of vehicle total or theft, auto insurance policies pay out the actual cash value (ACV) of a vehicle at the time a claim is made. However, if you financed your vehicle, your settlement may not cover the amount you still owe. Gap insurance covers the difference between the insurance payout and what you owe on the lease or loan.

According to the Insurance Information Institute, you should consider gap insurance if you:

• Put down less than 20 percent when you financed the car.
• Financed for five years (60 months) or more.
• Leased your vehicle (you’re often required to have gap insurance with a lease).
• Bought a vehicle that loses value faster than the average, like a luxury car.
• Rolled over negative equity from an old car loan into the new loan.¹

If you own your car outright, you do not need to purchase gap insurance. If you financed a vehicle, and are “underwater” or “upside down” on your auto loan — meaning the market value of the car is less than what you owe — it’s a good idea to consider gap insurance.

How do you know if you’re underwater?

1. Find your car’s value by entering your vehicle’s year, model, mileage, location, condition, and accident history on the Kelley Blue Book website or the National Automobile Dealers Association’s website.² There’s no single, objective source for a car’s value, because prices fluctuate due to factors such as industry developments and economic conditions.
2. Determine your loan balance by subtracting what you’ve already paid toward the loan from the original total loan amount, accounting for interest.
3. Compare the value of your car to your outstanding loan balance. If the value of the car is less than the loan balance, you’re underwater (this is also known as having negative equity).

Let’s say you buy a new car. A month later, you get into an accident and total your car. At the time of the accident, you still owe $30,000, but the car is only worth $26,000.

You have a $500 insurance deductible, after which your collision car insurance coverage pays you the value of the car at the time of the accident. So, after the deductible, your insurance pays $25,500. But you’re still on the hook for $4,500.

Gap insurance helps you pay that difference. Typically, it does not cover the deductible. But occasionally, some gap policies cover the deductible too.

Here’s a breakdown of how gap insurance works, using that example scenario:

Keep in mind that gap insurance only pays toward the balance of the loan. If you need to replace your car, consider adding new car replacement coverage to your insurance policy.

Gap insurance can be purchased through your existing auto insurance provider, car dealerships, banks or credit unions, or a gap insurance provider. Typically, dealerships offer significantly more expensive gap insurance than auto insurers, financial institutions, or a stand-alone provider.

See if your insurance company offers gap insurance as an add-on to your current policy. Companies like Liberty Mutual, Nationwide, Travelers, and Erie made our list of recommendations for the best gap insurance providers.

Keep in mind that most providers require you to have both collision and comprehensive coverage before you can purchase a gap policy (often, your lender requires these coverages, too). If your insurance doesn’t offer gap coverage, you may be able to buy it online from a stand-alone gap insurance provider. If you lease your car, check the terms of your lease — the dealership may include it automatically.

Gap insurance purchased through a dealership can cost anywhere from $500 to $700. Gap insurance purchased through an auto insurance provider typically adds an additional $20 to $40 on your annual premium. The exact cost depends on certain factors, like the value of your car at the time you purchased the policy, your age, where you live, and your claims history.

Dealerships or lenders typically charge an upfront flat fee for gap insurance. It may also be added into your loan, in which case you’ll also be charged interest.⁵ If you can’t get gap coverage from your insurance provider, a credit union will often be cheaper than a dealership.

In the unfortunate event you get into an accident or someone steals your new car, gap insurance can help. But it doesn’t cover everything.

What It Covers

Gap insurance covers total loss of vehicle from an accident or theft. Keep in mind that most insurers require you have both collision coverage and comprehensive coverage to purchase gap insurance. In the case of theft, you’ll need comprehensive coverage for the insurance to pay you the actual cash value of the car.

What It Doesn’t Cover

Gap insurance usually doesn’t cover:

• Insurance deductibles: Typically, gap insurance does not cover your deductible, although some policies might. Let’s say you have a $500 deductible on your collision coverage, after which your insurance pays out the value of the car. Gap insurance will help you cover the difference between the actual value of the car and what you owe on the loan, but it won’t go toward the $500 deductible.
• Missed loan payments or late fees: Gap insurance does not cover the cost of any missed loan payments or late-payment fees on your lease.
• Mechanical issues: Like standard auto insurance, gap insurance does cover losses from mechanical issues such as engine failures.
• Bodily injury and related costs: Damages such as bodily injury, medical expenses, lost wages, or funeral costs are not covered by gap insurance.

If your car is worth less than what you owe, even if only for a few months, gap insurance is probably a good idea. That’s especially true if you wouldn’t be able to afford to pay off your loans in the event of an accident or theft.

In general, you can drop gap insurance after you’ve owned the vehicle for two to three years. By then, you should owe less on the loan than the vehicle is worth. When in doubt, check your loan balance against the current estimated value of the car.

The below table shows the protection typically offered by gap insurance, collision coverage, and comprehensive coverage, as it relates to financed vehicles:

If you’re ineligible for gap insurance or it doesn’t meet your needs, you might consider these other options.

Loan/Lease Payoff Insurance

Some insurers use the term “loan/lease payoff insurance” interchangeably with “gap insurance.” Loan/lease payoff insurance is often available for used cars where gap insurance is not, and typically covers 25 percent of the actual cash value of the vehicle. Progressive is an example of a company that offers this coverage.

Let’s say you paid $40,000 for your truck, and someone steals it a month later. In that time, the value of the truck depreciated to $30,000. Loan/lease payoff insurance will pay you 25 percent of the truck’s value, which is $7,500. While loan/lease payoff doesn’t pay the entire remainder of a loan like gap insurance does, it usually covers the difference or close to it.

New Car Replacement Insurance

New car replacement insurance helps you pay for a new car (minus the deducible) to replace your former vehicle should something happen to it. Typically, new car replacement insurance costs more than gap insurance. It’s a good choice if you’re more concerned with the cost of buying a new car than the outstanding balance of your current loan.

Better Car Replacement Coverage

In the event of total vehicle loss, better car replacement coverage gives you money to purchase a newer model with fewer miles.⁶ For example, Liberty Mutual offers money toward a vehicle that is one model year newer with 15,000 fewer miles. Better car replacement coverage is a good option if you buy a used vehicle, which often isn’t eligible for new car replacement or gap insurance.

Depending on how you financed your new vehicle, it may be worth less than what you owe. When you’re “underwater” on your auto loan, gap insurance is often a good idea. Your car insurance provider, bank, or credit union will often have cheaper gap insurance than a dealership.