What is gap insurance, what does it cover and is it worth it?

Gap insurance is a type of auto insurance coverage that covers the difference between what you owe on your car and its actual cash value if it is damaged or totaled. It is optional coverage, and you should consider buying it if you have leased or financed your vehicle.

Read this comprehensive guide to know what gap insurance covers and how you can get it.

What is gap insurance?

If your insurer totals your vehicle by a covered peril, such as an accident, theft, fire, flood, tornado, vandalism, or hurricane, the insurer will pay you the actual cash value for your car, if you have comprehensive and collision coverage. This amount is often considerably less than the amount you still owe on your loan or the amount due for a lease payoff.

When the amount of your actual cash value (ACV) payout is less than what you owe on your lease or loan, the loss from this financial shortfall is the “gap” you can be left owing. This is where gap insurance may save the day.

What does gap insurance cover?

If your car is stolen or totaled, gap insurance will pay the difference between the ACV of the vehicle and the current outstanding balance on your loan or lease. Sometimes it will also pay your regular insurance deductible.

Car owners often assume that if their car is totaled, it will be replaced at the amount they paid, or at least the amount they owe. This is not so. That is why many car insurance companies offer gap insurance (or loan/lease payoff insurance) as optional coverage.

You must also have comprehensive and collision coverage to buy gap coverage, but if you lease or finance your car, those are typically required.

What isn’t covered by gap auto insurance?

Gap insurance usually won’t pay for:

• Overdue lease/loan payments
• Costs for extended warranties, credit life insurance or other insurance purchased with the loan or lease
• Carry-over balances from previous loans or leases
• Financial penalties imposed under a lease for excessive use
• Security deposits not refunded by the lessor
• Amounts deducted by the primary insurer for wear and tear, prior damage, towing and storage
• Equipment added to the car by the buyer, meaning that only factory-installed equipment is covered
• Mechanical issues, such as engine or transmission failures, or any other car problems that are not losses covered by your car insurance policy

Does gap insurance cover theft?

Yes, gap insurance covers your car if it’s stolen and not recovered. It works with your comprehensive insurance to cover theft. Comprehensive will pay out up to the actual cash value of your car, minus your deductible if your car is stolen. This coverage would then pay the difference between that amount and what you owe on your loan.

How does gap insurance work?

Let’s look at an example of how gap coverage refunds work to protect you when you owe money on your car and it’s stolen or totaled.

This is how a “gap” occurs (using fictitious numbers):

• You buy a car that costs $25,000 and drive it off the lot.
• After paying the down payment, you owe $24,000 in car payments over five years (0% interest loan = $400 car payments).
• You purchase comprehensive and collision coverage with a $500 deductible to protect you against damages and loss.
• You have an accident while you’re still upside down on your loan or lease (meaning you owe more on a car than it’s worth) and your vehicle is totaled.
• The insurance company determines that the actual cash value of the car is only $22,000, but at the time of the loss, you still owe $23,500.
• Gap insurance should pay the difference plus your deductible, totaling $2,000. (Note: not all gap policies pay the deductible).

Here are the line items:

• Loan payoff at the time of accident: $23,500
• Vehicle’s actual value at the time of accident: $22,000
• Your deductible: $500
• Physical damage insurance pays: $21,500 ($22,000 minus $500 deductible)
• Gap insurance pays the difference between what is owed and what the physical damage insurance company pays (plus your deductible): $2,000

What is loan or lease coverage and how it is different from gap coverage?

While the terms gap insurance and loan/lease coverage are often used interchangeably, they aren’t quite the same coverage normally. Gap insurance will pay the difference between the amount you still owe on a vehicle and actual cash value (ACV) paid out by your car insurance company.

Lease/loan coverage typically has limitations on how much it will pay out, such as 25% over the determined ACV of your vehicle. Both are minus your deductible.

To make sure lease/loan coverage would work for you, run the numbers. For instance, if in the example above the vehicle was worth $20,000 then 25% of its value would be $5,000 and that is the same as the gap ($25,000 due – $20,000 paid by the insurer and your deductible = $5,000) so it would have covered the whole amount.

Do I need gap insurance?

Here’s why you need gap insurance:

Many car owners don’t take into account the depreciation that takes place with a new car. Within minutes of driving off the lot, a new car can be worth 10% less than what you just paid.

In our example above, if you owned the car for three days, and the car was totaled, you could owe 10% to 20% of the $24,000 ($2,400 to $4,800 out of your pocket) even though you purchased full coverage.

And depreciation continues over the life of your car, especially in the first five years you own it. According to CarFax reporting on current depreciation rates, the value of a new vehicle can drop by more than 20% after the first 12 months of ownership. Then, for the next four years, you can expect your car to lose roughly 10% of its value annually.

This means that a new car can be worth as little as 40% of its original purchase price after five years.That means the payout you would get for the value of the car is likely to be much less than what you owe for at least the first several years.

If I bought my car outright, do I need gap insurance?

There’s no reason to buy this coverage if you bought a car with cash and own it without a loan. It is for when you owe more than the value of your vehicle. If you have the car paid off and it’s no longer financed, you don’t owe anymore more than the car is worth, and so there would be no payout from gap coverage.

If I paid a high down payment, do I need gap insurance?

If you put down a decent down payment, your vehicle doesn’t depreciate at a steady pace and you’re paying down the balance of the loan each month, you typically wouldn’t need gap insurance coverage.

Gap car insurance is only needed if you have negative equity in your car (owe more than the value of the vehicle) since this coverage only pays for the balance of the loan left after the ACV is paid out when your car has been found to be a total loss by an insurer.

Is gap insurance necessary and required by law?

While you need gap insurance if you owe more on a vehicle than its value, gap coverage isn’t required by any state as part of your car insurance policy.

Gap insurance coverage is optional coverage; however, it’s not uncommon for lease contracts to have gap insurance included in them. Sometimes it’s referred to as auto loan/lease coverage or loan/lease payoff coverage.

If a lender of leased cars requires gap insurance, they must include it within the lease’s cost itself. This means that the monthly price quoted by the dealer must include gap coverage when they mandate you carry it.

There are some financial institutions that may want you to have gap coverage as part of your auto insurance policy on the car you’re purchasing. If this is the case, your loan or lease papers should note this.

If you have declined gap insurance, a dealer shouldn’t be able to add it to your loan amount or charge you for it in another way. Even though it may be helpful if you owe more on the vehicle than its ACV and were to be in an accident, you should have the right to turn down this coverage and thus not be charged for it.

For example, the California Car Buyer’s Bill of Rights requires disclosure of the price of items commonly packed into loans, such as theft etching on windows and other car parts, gap insurance or extended service contracts.

In general, dealers anywhere should provide car buyers with an itemized price list for all these items, such as warranties and insurance, if the items are being financed.

If you have a charge for gap insurance from your lender and don’t have this coverage, discuss the matter first with the financing company that added into your payment. Unless you signed paperwork stating that you would add gap coverage to the car at the time of purchase as part of your finance or purchase agreement you should be able to decline it and get a refund.

If you don’t want gap coverage and have problems getting it removed, try contacting your state agency’s consumer division. The office of the insurance regulator should be able to help you.

Is gap insurance worth it?

The answer to this question depends on your situation. Gap insurance may be worth it if you owe a lot more than what the car’s worth.

So, for instance, if you bought an $80,000 car and only put down $5,000, you may want to get gap insurance so you’re not stuck having to make up the difference if an insurer totals your car.

If the outstanding loan or lease balance is only slightly more than the vehicle’s, you may want to chance it. In that case, it’s a good idea to put some money aside in case you need it if an insurer totals your car.

In addition to depreciation, you may find gap insurance worth the money for these reasons:

• You owe more on your loan than what your car is worth
• You made a low down payment on your car, under 20%
• You don’t have enough savings to pay the gap between your loan and your car’s value
• You drive more than 15,000 miles a year, as this accelerates your car’s depreciation
• The model car you have depreciates at a faster rate than the typical average

Does gap insurance always pay out?

It pays out as long as the total loss claim isn’t denied and you have car insurance coverage in effect. However, if you have missed car payments, that amount will be deducted, says Gusner. For instance, if you are late on a car payment of $400, that amount would be deducted from your gap insurance pay out.

When gap insurance doesn’t pay?

There are instances when gap coverage won’t pay out. For example, if the claim for the totaled or stolen car is denied for some reason, or if your car insurance coverage lapsed, your gap insurance won’t come into play. And, because it’s limited to claims that declare your car a total loss, it wouldn’t cover the following, which is covered under other types of car insurance:

• Injuries: Gap insurance does not cover medical bills. Your bodily injury liability would pay for medical expenses for those you injure in an accident you cause. Your own injuries would be covered by the other driver’s liability insurance or your personal injury protection or MedPay insurance.
• Property damage you cause: Damage you do to another car or someone else’s property would not be covered by gap insurance — your property damage liability would.
• Damage to your car that isn’t your fault that doesn’t result in a total loss: Even if your car sustains serious damage, gap insurance will only cover it if it is considered a total loss and you can no longer drive it. The other driver’s property damage liability would pay for damage to your car. Or, collision insurance would cover it, regardless of fault. In both cases, gap insurance would not cover the claim because the car wouldn’t be declared totaled.

Will gap insurance pay your deductible?

The answer depends upon your gap insurance policy. Some policies pay the deductible and some don’t. When it pays the primary insurance deductible amount, the deductible amount isn’t actually reimbursed back to you. Rather, the primary insurance deductible is taken from the payout of your totaled vehicle and covered as part of your unpaid loan balance, which gap insurance pays.

How to get gap insurance for cars?

You can buy gap insurance for cars from the following:

• The bank or financial institution that loaned you the money to buy the car
• The dealership where you bought the car
• Your car insurance company
• From a company that specializes in stand-alone gap insurance policies

Can I get gap insurance without primary insurance?

You need to have a standard auto insurance policy to get this coverage. For your gap insurance to be in effect, you need to carry physical damage coverages of collision and comprehensive on your vehicle in addition to your state’s required minimum liability insurance requirements. This “full coverage” of liability and physical damage coverage is also normally required by the bank or lending institution where you got your car loan.

Even if you get a stand-alone gap policy, you still need your state’s minimum auto insurance coverage. That’s the insurance coverage you need to drive legally.

Can I purchase gap insurance on a used vehicle?

Yes, typically you can. State laws and insurance companies’ guidelines vary, but there are gap policies that are available for used cars that are financed. It’s beneficial when the value of a vehicle, whether new or used, depreciates while you still owe money on the loan or lease.

Is gap insurance acceptable as proof of insurance?

A gap policy isn’t accepted by any Department of Motor Vehicles as proof of insurance. It’s not the right type of insurance needed to show financial responsibility when you’re going to register, or renew registration, on your vehicle.

Showing proof of gap coverage to law enforcement wouldn’t help if they ask you for proof of insurance. It is optional coverage that only helps you out in a total loss situation, it doesn’t provide the state-mandated liability coverage that police want to verify that you have on your vehicle.

Can I get gap insurance on a loan that is not for a car?

You cannot get gap coverage for lines of credit that may be used for purposes other than a vehicle. It doesn’t work with mortgage loans, credit lines, balloon payments or other types of non-vehicle specific loans.

If you have used money from your Home Equity Line of Credit (HELOC) to purchase your vehicle, gap insurance would not cover this type of loan since the HELOC is not specifically to be used for a vehicle loan.

Gap coverage is normally only able to be purchased and used when you have received your money through a conventional auto loan or lease to obtain your vehicle.

Can I buy gap insurance if my loan is from an individual?

Gap policy providers won’t offer coverage if your loan is through a private individual.

When dealing with a bank or finance company, the gap insurance carrier knows the terms, sees the paperwork, etc. With a private party loan, it is hard for the gap carrier to be assured that the loan is only for the vehicle, payments were made properly, etc. – all things that an insurer requires.

Can you buy gap insurance anytime?

Gap insurance providers’ terms and guidelines differ; in general gap insurance is available on new, used and refinanced cars, trucks and SUVs leased, purchased or refinanced within the past 12 months. So if you know within the year after financing, leasing or refinancing your vehicle that you owe more than its ACV gap coverage could be beneficial for you.

Can you get gap insurance after an accident?

No. You cannot get gap insurance after an accident that totaled your car. This means you’ll have to pay off your car loan on your own. 

— Michelle Megna contributed to this story.

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