Gap Insurance: Understanding Loan Protection

Gap insurance is an optional form of auto insurance that covers the difference between the amount owed on a car loan and the car's value in the event of theft or a total loss. It is designed to protect drivers from being left out of pocket if their car is stolen or written off and the insurance payout doesn't cover the amount they still owe on the vehicle. Gap insurance is typically purchased from car insurers or dealers, and it is often required by auto loan providers and leasing companies. The cost of gap insurance depends on individual factors, such as the car's value, state, and driving record. It can be added to an existing car insurance policy or bought separately from a dealer.

When is gap insurance worth it?

Gap insurance is worth it in certain situations. If you don't have a car loan or a lease, you don't need gap insurance. However, if you do have a lease or loan, you may want to consider it. Gap insurance is designed to pay off your auto loan if your car is stolen or deemed a total loss and you owe more than its depreciated value.

• You have a very long loan term or a high-interest rate. For example, a loan term of 84 months or an APR of 15%.
• You put a lot of miles on your car, causing it to depreciate quicker than your loan balance. For instance, putting 30,000 miles on the car in the first year.
• You have negative equity from a trade-in, and you end up borrowing more than the car is worth.
• You have a car that depreciates quickly as soon as you drive it off the lot.
• You have a low down payment on a new car, a longer financing term, or you're leasing your car.
• You plan to add a lot of miles to your car, which will impact its value quickly.
• You've taken out a long-term car loan of five years or more.

In these situations, gap insurance can provide added financial security and prevent you from paying money out of pocket if your car is stolen or totaled. However, it's important to note that gap insurance doesn't cover your comprehensive or collision deductible, and it's not required by any insurer or state. Additionally, once your car loan is less than the current value of your car, you can drop the insurance.

What does gap insurance cover?

Gap insurance covers the difference between what you owe on a car lease or loan and the amount paid out in a total loss settlement from an auto insurer, minus your deductible. This is often referred to as the "gap".

For example, if you owe $25,000 on your loan and your car is only worth $20,000, your gap coverage covers the $5,000 gap, minus your deductible. Gap insurance is applicable if your vehicle is stolen or deemed a total loss.

It's important to note that gap insurance doesn't cover other property or injuries as a result of an accident, nor does it cover engine failure or other repairs. In most cases, it also doesn't cover your comprehensive or collision deductible.

How does gap insurance work?

Gap insurance, or guaranteed asset protection, is an optional form of auto insurance that covers the difference between the amount you owe on your car loan and the amount your car is worth in the event of theft or total loss.

Let's say you buy a car for $30,000 and finance it with a loan for the same amount. You've been making all your payments, but a few years later, your car is only worth $20,000. However, you still owe $25,000 on your loan, leaving a $5,000 gap. If your car is then written off or stolen and not recovered, your comprehensive insurance would pay out $20,000 (the current value of the car) minus your deductible. Without gap insurance, you would only receive this amount, leaving you with a $5,000 shortfall. With gap insurance, your insurer would cover this $5,000 gap, allowing you to pay off your loan in full.

Gap insurance is designed to protect you from depreciation. Once you buy a car, its value starts to decrease, and this depreciation can leave a significant gap between what you owe and the car's value. Gap insurance is particularly relevant if:

• You lease your car
• You made a lower down payment on your car (less than 20% of the sale price)
• You have a longer financing term for your vehicle
• You want protection against depreciation
• You have a loan rollover, where you owe more on your loan than your car is worth at the time of renewal

If you paid a large down payment on your vehicle, have paid off a significant portion of your loan, or own your car outright, you likely won't need gap insurance. Additionally, if the amount you owe on your loan is less than or only slightly more than your car's value, there would be little to no gap to cover, so gap insurance wouldn't be necessary.

Gap insurance typically lasts for the duration of your policy. However, you can drop the insurance once you owe less than what the car is worth.

How much does gap insurance cost?

The cost of gap insurance depends on where you buy it from. Auto insurers typically charge a few dollars a month or around $20 a year for gap insurance. However, lenders and dealerships sell gap insurance for a flat rate, usually between $500 and $700. This is the most expensive option as the cost is rolled into your loan, and you pay interest on it.

If you buy gap insurance from your auto insurer, it will only increase your comprehensive and collision insurance cost by about five to six per cent on average. If you want to buy a standalone gap insurance policy, you can expect to pay a one-time fee of between $200 and $300.

Progressive, for example, allows policyholders to include gap insurance on their existing car insurance for as little as $5 per month.

Your cost depends on individual factors, like your car's value, and you'll also need to buy comprehensive and collision coverage.

When should you get gap insurance?

Gap insurance is a good option for drivers who:

• Owe more on their car loan than the car is worth. If you are currently making car loan payments, be sure to calculate the loan balance and weigh it against your car’s current cash value.
• Have a car loan that requires gap insurance. Some loan providers require gap insurance from the outset of your loan.
• Have a lease that requires gap insurance. Many auto leases require gap insurance as a protective measure. Some lease providers may already include gap insurance in the price of the lease.

Gap insurance is not required by any insurer or state, but some leasing companies may require you to purchase it. Also, when purchasing a new car, some dealerships may automatically add gap insurance to your loan — however, you can decline this coverage. Check your current car insurance policy and car lease or sale documents to find out if you have gap insurance.

You can generally only add gap insurance to your policy if you still owe money on the vehicle or lease. Although insurers’ guidelines vary, a company may require one or both of the following:

• Your car is no more than two to three years old.
• You are the original owner of the vehicle.

There are two main ways to buy gap insurance:

• From your auto insurer, as part of your regular insurance policy.
• Through the dealership or lender, rolled into your loan payments. With this arrangement, you’re paying interest on the cost of your gap insurance over the life of the loan, making the coverage far more expensive.

If you buy through your dealership or lender:

• Check your auto loan contract to see if you’re required to have gap insurance — not all lenders require it. However, your lender will generally require you to buy comprehensive and collision coverage.
• A dealer may automatically include gap insurance if you lease your car, so make sure to check your lease agreement.
• If you already bought gap insurance from your dealer and want to buy it from your insurer, you may be able to remove it from your car loan contract. Make sure you have coverage during the transition if you switch providers.

NerdWallet recommends buying gap coverage through your auto insurer rather than from a dealership to avoid paying interest on it. Not all car insurance companies provide gap coverage (or an equivalent) or offer it in all states, so if you decide you want this type of insurance, you may need to switch companies.

Frequently asked questions