Gap insurance is an optional add-on coverage that works with your comprehensive or collision coverage to protect you financially in situations where your vehicle is totaled or stolen and you owe more on your loan than the car's current value. This difference between loan balance and car value is known as the gap.
How gap insurance works to cover the gap between loan balance and vehicle value
When you purchase a new vehicle, it immediately starts to depreciate - sometimes rapidly in the first year. But your loan balance typically remains steady over the years as you make payments. This creates a situation where you often end up owing more on the car loan than the car is actually worth.
If the vehicle is totaled in an accident or stolen, your standard auto insurance policy will only pay up to the car's actual cash value (ACV) at that time. This is where gap insurance comes in to cover the difference:
Your regular collision or comprehensive coverage pays the ACV of the totaled vehicle, minus your deductible.
If you owe more on your loan than the car's ACV, gap insurance will pay the remaining balance so you are not left owing money on a vehicle you no longer possess.
For example:
| Item | Amount |
|---|---|
| Remaining loan balance | $15,000 |
| ACV paid by regular insurance | $10,000 |
| Gap insurance payout | $5,000 |
Without gap insurance, you would be responsible for that $5,000 difference. Gap insurance protects you from this expense.
What gap insurance covers:
- The gap between ACV and remaining loan balance
- Applies to vehicles that are totaled or stolen
- May cover negative equity from previous loans
What gap insurance does NOT cover
- Your deductible amount
- Injuries to occupants
- Routine maintenance and repairs
- Fees or penalties related to your lease or loan
Gap insurance acts as an essential financial safety net in situations where your vehicle is destroyed or stolen. While you hope to never need it, gap coverage provides peace of mind by ensuring you will not be stuck owing money on a vehicle you no longer have.
Most auto insurance companies and lenders offer gap coverage options. Evaluate your loan balance compared to car value to determine if gap insurance is a smart choice for your situation.
When gap insurance makes sense for comprehensive coverage
Gap insurance can be a valuable add-on to your comprehensive coverage in certain situations where you are more likely to end up owing more on your loan than the vehicle's value if it gets totaled. Consider gap insurance when:
Depreciation will likely leave a large gap between loan balance and car value.
- Vehicles tend to depreciate fastest in the first 1-3 years. Luxury and hybrid cars often have higher than average depreciation rates.
You have a longer term auto loan (5-6 years).
- The longer you finance, the more likely you'll owe more than it's worth later on.
Your down payment is less than 20% of the purchase price.
- Low down payments lead to faster negative equity, increasing the gap.
You leased the vehicle.
- Lease agreements often require gap coverage since leased cars depreciate rapidly.
New car purchases are the most common situation where gap insurance makes sense. Other examples include:
Rolling over negative equity from a previous loan into your new auto loan. Gap coverage can protect you if that creates a large gap.
Having a loan term over 60 months. Longer loans mean slower equity building so you owe more over time.
Buying a car with higher than average depreciation like luxury brands or hybrids. These see values drop more over the loan term.
Owing substantially more than the current trade-in value if you want to upgrade vehicles while still having a loan.
While not mandatory, gap insurance can give valuable financial protection in these higher risk situations. It covers an expense you'd otherwise be responsible for if the vehicle was totaled or stolen. Carefully consider if gap coverage makes sense for your auto loan situation.
What gap insurance covers and does not cover
If you choose to add gap coverage to your comprehensive auto insurance policy, it is important to understand exactly what it does and does not cover.
What gap insurance covers:
The gap between your vehicle's actual cash value (ACV) and the remaining loan balance you owe, if the vehicle is totaled or stolen. This protects you from having to pay off a loan for a car you no longer have.
May cover negative equity that was rolled over from a previous loan into the financing for your current vehicle, depending on the policy specifics. This negative equity can widen the gap.
Applies when your car is stolen or totaled in an accident covered by collision or comprehensive insurance. The gap policy pays after your regular insurance settles.
What gap insurance does NOT cover:
The deductible amount on your standard insurance policy. You are still responsible for paying the deductible.
Injuries to occupants involved in an accident. Medical payments coverage or health insurance would handle bodily injury expenses.
Routine maintenance, mechanical repairs or damage that falls under your warranty. Gap insurance strictly covers the financial loan gap, not vehicle repairs.
Fees, penalties or excess wear and tear charges related to early lease termination. Gap insurance does not cover these additional lease expenses.
Late loan payments or financing charges. It only pays the remaining principal balance, not other amounts you may owe the lender.
Down payment on a replacement vehicle. Gap insurance only settles the previous loan balance, it does not give you cash for a new car purchase.
Carefully read your gap policy to confirm what is excluded. Also verify that the remaining loan balance it pays includes any negative equity rolled into your financing. By understanding exactly what gap insurance does and does not cover, you can determine if it's a worthwhile add-on to your comprehensive auto policy.
Buying gap insurance from insurance company vs. dealer
If you determine gap coverage would be beneficial for your situation, you have two main options for purchasing it:
- Through your auto insurance company
- From the car dealership or lender as part of your loan
While the dealership route may seem more convenient, there are advantages to buying gap insurance from your insurance provider instead:
Insurance company advantages:
Lower cost - Gap coverage added to your policy typically costs $200-$300 total for the length of the loan. Dealers may charge over $500 upfront.
No interest charges - When gap is added to your loan amount, you pay interest on it over the full financing term. Going through your insurer allows you to avoid this additional interest cost.
Flexibility - You can drop the coverage from your policy once you no longer need it. With dealership gap insurance locked into your loan, you cannot remove it.
Potential discounts - Some insurers offer multi-policy or loyalty discounts that could lower your gap insurance rate.
Better policy options - Dealers often offer minimal gap policies. Insurers may offer enhanced coverage like new car replacement.
Dealership/lender advantages:
Convenience of adding it to the loan with little effort.
May be required for leases or loan approval.
That said, the financial benefits typically make buying through insurance companies the best way to get gap coverage. Just be sure to verify the gap policy offered includes protection for any negative equity rolled into your loan. While dealer gap insurance is simpler, insurance company gap coverage offers more savings and flexibility.
Alternatives like new car replacement coverage
Although gap insurance can be valuable protection in many situations, some auto insurance companies offer alternative add-on coverages that may better fit your needs:
New car replacement coverage
Instead of just covering the gap between loan balance and ACV, this option pays to replace your totaled new car with a brand new model of the same make/model. Requirements may include:
- Vehicle is less than 1-3 years old
- Has under 15,000-40,000 miles
- Repair costs exceed a specified percentage of MSRP
Benefits include:
- Replaces your car with a new version, rather than just settling the old loan. This provides the peace of mind of having an undamaged vehicle.
- Covers gap amount plus remainder needed to purchase the replacement new car.
- No depreciation deduction taken by the insurer.
Downsides compared to gap insurance:
- Typically more expensive premiums
- Must meet vehicle age and mileage requirements
- Insurer sets threshold for when they will replace versus repair
Better car replacement coverage
This pays to replace your totaled vehicle with a model that is one year newer with at least 15,000 fewer miles. This essentially lets you upgrade your car if it's destroyed. Limitations may apply on vehicle age or value.
Consider alternatives like new and better car replacement to decide if they are more beneficial for your situation than traditional gap coverage. They provide more than just gap protection. Your auto insurance agent can explain the details so you can make the right choice.
Factors in vehicle depreciation
A vehicle's depreciation rate has a major impact on whether you are likely to end up owing more than it's worth. Faster depreciating vehicles have a wider gap between loan balance and value, making gap coverage more beneficial.
Vehicle factors that increase depreciation:
Luxury brands depreciate faster on average
- BMW, Mercedes-Benz, Lexus, Infiniti, etc.
- Luxury car values drop more over time
Hybrid and electric vehicles
- Battery replacement costs lead to higher depreciation
- Concerns about evolving technology
Leased vehicles
- Monthly payments do not build equity
- Need to return in good condition
High mileage/wear and tear
- Decreases resale value
- May indicate unreported problems
Desirability and resale demand
- Sports cars and SUVs tend to hold value
- Less popular models depreciate more
Ways to slow vehicle depreciation
- Make a larger down payment
- Quickly builds equity to lower gap
- Shorter loan term
- Pay off loan faster before depreciation
- Purchase a gently used 1-3 year old model
- Avoids the steepest initial depreciation
- Take good care of the vehicle
- Maintain good condition to preserve value
- Sell before major mileage milestones
- High miles significantly lower value
Checking a vehicle's projected depreciation rates can indicate if gap insurance will be beneficial. The faster it loses value, the more likely you'll end up owing the bank more than it's worth. Consider the depreciation factors before purchasing your next vehicle.
How insurers determine if a vehicle is totaled
For gap insurance to apply, your vehicle must be declared a total loss - meaning the cost to repair it exceeds a certain percentage of its value. Here is how the total loss thresholds work:
Each state sets its own regulations for when a vehicle is considered totaled. Thresholds range from 50% to 100%.
The threshold is based on the car's value before the incident occurred.
Value is determined by sources like Kelley Blue Book or NADA. Some states specify using retail value.
If repair costs exceed the state's total loss threshold percentage of the car's pre-incident value, the insurer declares it a total loss.
For example:
- State threshold: 75%
- Car value before incident: $10,000
- 75% of value = $7,500
- If repairs exceed $7,500, the car is totaled
Common state total loss thresholds:
- 50%: Iowa, Wisconsin
- 60%: Oklahoma
- 65%: Nevada
- 70%: Alaska, Minnesota, New York
- 75%: Kentucky, Louisiana, North Carolina, Virginia
- 80%: Oregon
- 100%: Colorado, Texas
Insurers may also declare a total loss if repairs are deemed impractical - like with water damage or a twisted frame. So even if thresholds are not met, the car can be totaled.
The higher your state's threshold:
- The more damage required to total a vehicle
- The less likelihood of relying on gap insurance
- But more risk of extensive repairs while still owing on a loan
Knowing your state's regulations provides insight into when gap may come into play after an incident. The total loss threshold is a key factor in whether your car is repaired or paid off as a total loss.
Pros and cons of gap insurance
Gap insurance can provide valuable financial protection, but also comes with drawbacks to consider:
Pros of gap insurance:
Covers the gap between what your car insurance pays and what you still owe on your loan if your vehicle is totaled or stolen. This protects you from having to pay off a vehicle you no longer possess.
Peace of mind knowing you won't be stuck with negative equity if your car is destroyed. This security is reassuring, even if you hope to never use gap coverage.
Typically inexpensive when added to an auto insurance policy - costing a few hundred dollars for multiple years of coverage. Far cheaper than paying off a loan for a car you don't have.
Allows you to purchase the car you want by minimizing financial risk if it gets totaled and declines in value faster than expected.
Cons of gap insurance:
Added cost of another insurance coverage. You have to weigh the benefit against the premium expense.
If your loan payoff amount barely exceeds the car's value, the gap payout may be small and not worth the price of the policy.
Coverage limits may apply, especially on policies provided through dealerships. Limits may also apply on negative equity coverage.
Doesn't cover injuries, routine repairs, or additional fees associated with your loan or lease. Other policies would be needed to cover these expenses.
If you purchase an asset protection warranty, it may overlap with some gap insurance benefits.
Carefully weighing the pros and cons will help determine if gap coverage is right for your situation. It can provide vital protection, but also comes with drawbacks like added cost and limited benefits. Evaluate your specific car, loan, driving habits and budget to decide if gap insurance fits into your comprehensive coverage needs.
Conclusion on evaluating need for gap insurance with comprehensive coverage
Gap insurance can be a smart addition to your auto policy depending on your vehicle loan situation. Consider whether your car's depreciation rate and loan balance mean you are at risk of owing more than it's worth if your vehicle gets totaled.
Carefully weigh the pros and cons for your situation. Does the peace of mind justify the added cost? Shop insurance quotes to find the best comprehensive coverage and gap insurance rates.
Review your loan details and research your car's depreciation. Determine if you should add gap or if an alternative like new car replacement better fits your needs. An informed decision will ensure you have the right protections without overpaying. Gap insurance can provide vital financial protection when you need it most.
FAQs
Q: Can you buy gap insurance after you purchase a car?
A: Yes, you can buy gap insurance after you purchase a car. However, it's usually more expensive to buy gap insurance from a car dealer after you've already purchased the car.
Q: How long does gap insurance last?
A: Gap insurance usually lasts for the duration of your car loan. However, some insurance companies may offer gap insurance for a shorter period of time.
Q: Is gap insurance worth it?
A: That depends on your personal situation. If you have to pay a loan for more than 60 months or the actual cash value of your car will significantly drop in a short period of time, you should add it to your policy. However, if almost paid your loan or the actual cash value of your car is too low, you should not add Gap Insurance.
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