What happens if your car is totaled in an accident? And what happens if the insurance payout for the vehicle’s total value is less than the outstanding balance on your auto loan? This is where gap insurance can help.
Gap insurance is not a standalone type of car insurance policy. Rather, it is a type of additional coverage, often called an insurance rider. Gap insurance supplements your underlying policy, bridging the gap between an insurance payout and your auto loan debt.
Americans in every state except New Hampshire and Alaska are required to purchase liability car insurance in case they get into an accident. If the accident is your fault, your liability insurance will pay for the other driver’s damages.
But while auto insurance is the standard for everyone – whether they are driving a leased vehicle, a new car they own and finance, or a used vehicle – a car insurance company has no vested interest in helping the driver settle their financial obligations in a total loss.
A total loss occurs any time the cost of repairing a vehicle exceeds its fair market value. There are two main types car insurance coverage: collision coverage and comprehensive coverage. Collision covers accidents, while comprehensive covers other events like hail damage, fallen trees, or parking lot dings. Unfortunately, neither type of coverage will have your back if your car is totaled and you still owe money to your lender. While the insurer will pay for the fair market value of your vehicle, there may still be a gap between that and how much you owe. That’s where a gap advantage is a good optional piece of coverage.
8 Common Questions About Gap Insurance
1. What is gap insurance?
Gap insurance stands for guaranteed auto protection. This type of insurance bridges the gap between the value of your car and the money you owe on it.
2. How does gap insurance work?
Let’s say you purchase a vehicle with a $30,000 sticker price, and make a $3,000 down payment, bringing the remaining total owed to $28,000. Now let’s say you get a 72-month auto loan with a 9% interest rate, leaving you with a monthly payment of around $487 per month.
After just one year of driving your new vehicle, it’s totaled in a car accident. You still owe around $24,600 to your lender, but there’s a problem: your car (like most vehicles) has depreciated significantly by 20%. In this case, your insurance company will cut you a check for $24,000, the cash value of the vehicle. There is a gap between this number and what you still owe the lender; gap insurance would cover this gap.
Of course, in this example, the gap is relatively small. But what if your down payment was even lower and the car had depreciated even more? It’s in situations like these that gap insurance can help you avoid losing money if your car is totaled and you still need to pay it off.
3. What does gap insurance cover?
Gap insurance covers the gap between the vehicle’s insured value and your outstanding car loan balance. It’s important to realize that a vehicle’s insured value is most often going to be its actual cash value – meaning, how much you would get for the car selling it as-is. This is also known as the sticker price it would have on a used car lot, determined by the Kelly Blue Book or similar service.
Unless your policy states otherwise, you do not get the replacement value for the totaled vehicle, which would allow you to buy another one of the same make and model at the same price. But the actual cash value is going to be less than the outstanding balance of your loan or lease agreement since cars depreciate in value rather quickly. Gap insurance is the solution to this problem, and it’s available for pretty much every type of vehicle sold to the consumer market.
4. What does gap insurance NOT cover?
Remember that gap insurance simply covers the gap between a payout for a totaled car and the money you owe your lender, which is often called negative equity.
Gap insurance does not cover any other type of situation, like a car accident that leaves your car drivable but in need of repairs. Gap insurance also does not cover mechanical failure or issues with the vehicle such as those that might occur with tires.
Gap insurance is not a policy for roadside coverage like replacing tires or towing services, nor does it cover any deductibles. Keep in mind that for concerns such as mechanical failure, your car dealer or lender might offer additional warranties or coverage.
Gap insurance also does not cover theft. That type of incidence will often be covered by comprehensive car insurance, but check with your insurance agent to make sure.
5. How much does gap insurance cost?
Gap insurance is actually very inexpensive. It can cost around $400 to $700 per year when purchased with the vehicle from the dealer. You can expect to pay $20 to $40 per month when gap insurance is attached as a rider to your insurance policy by your vehicle’s insurance provider.
The exact rates will depend on the type of vehicle you’re purchasing, your down payment, and your location. For instance, if you were shopping around for life insurance, your premium will depend on factors like your age and your health. Your best bet is to start with your current car insurance provider and see the cost of a gap insurance rider. Your agent may be able to offer you a discount based on your customer history and other insurance products of theirs that you’ve bundled.
Many times, an insurance company will automate payments right from your credit card, bank account, or credit union, which makes the already fairly low monthly payment even less burdensome.
6. Is gap insurance required?
Gap insurance is not required in most cases. However, it is often recommended to car buyers making a down payment of less than 20%. In this way, gap insurance is similar to private mortgage insurance or PMI (not to be confused with homeowners insurance) which a homeowner will often need if their down payment is less than 20%. The difference is that PMI is designed to protect the lender, while gap insurance protects the borrower.
Some auto lenders will require gap insurance for certain types of vehicles that have more tendency to depreciate quickly, such as SUVs and luxury sedans. In most states, dealers are required by law to present you with gap insurance. However, keep in mind that the upfront packages they sell for the life of the vehicle end up being more than what you would pay for an insurance rider.
In summary, you really only need gap coverage when the cash value of your vehicle is less than your outstanding loan balance or lease agreement. After a few years of driving, these two numbers will even out and gap insurance will not be needed. There will eventually come a point when your loan is less than the value of your car. At this point, no lender will require gap insurance.
7. Does gap insurance cover the deductible?
Gap insurance does not cover the deductible of your policy. The deductible is the amount of money you have to pay out of pocket toward a car repair, with your insurer repaying the rest.
Some of the most common deductible amounts include $500 and $1,000, although there are others. As an example, a driver with a $500 deductible who has their car totaled will still need to put forth $500 of their own money toward a new vehicle or praying off the lender. Of course, if an accident was the fault of the other driver, the claim will be run through that person’s insurance (or recovered through a process called subrogation) and the driver of the totaled vehicle will ultimately owe nothing.
8. Is gap insurance the same as total loss protection?
Gap insurance is not the same as total loss protection. Gap insurance coverage is for bridging the gap between the payout for a total loss and the money you owe your auto loan lender.
Total loss protection, on the other hand, provides a credit toward the purchase of a replacement vehicle. If you purchase total loss protection, you may be able to get a new vehicle or a leased car once again, but you will still have a financial obligation to your lender. A gap insurance policy is the only thing that will bridge that gap between the outstanding balance and the fair market value of your vehicle when it was totaled, minus your deductible.
But while gap insurance is only needed when your vehicle’s value is less than your outstanding loan balance, total loss protection might be something you buy for the lifetime of the vehicle. Total loss protection will give you a credit towards a replacement vehicle – not only in the event of being totaled in an accident, but also in the event of a theft, which is something that guaranteed asset protection plans do not provide.
Gap Insurance: The Bottom Line
Unlike certain forms of insurance like health insurance, gap insurance is not something you will need all the time. Gap insurance is only meant to cover the difference between the money you owe and the cash value of your car.
If you are driving a car that depreciates quickly, gap insurance may be a good idea. Gap insurance also makes sense if you are putting down less than 20% since your outstanding loan balance will be quite large. If you are taking advantage of a special dealer financing offer, you may be in a similar situation because the lower interest rate makes a smaller down payment make more sense.
Purchasing a new vehicle can feel like a high-pressure situation, especially with a car salesperson who really wants to close a deal. Before closing the deal, do some calculations to determine how quickly the car will depreciate and how long you would potentially need gap coverage.
You can call your insurance agent while at the dealer and get a quote for gap coverage. Multiply that monthly payment for the gap coverage rider by how many months you’d need gap coverage for, and see if it’s more or less than the number the dealer is presenting you with. In some cases, you may find that you save a few hundred dollars getting gap coverage from your insurer instead of purchasing a plan from the dealer.
