Everything You Need to Know About Gap Insurance

In the event of vehicle total or theft, gap insurance covers the difference between the actual cash value of a vehicle, which your insurance settlement will pay, and what you owe on the lease or loan. (By the way, “totaled” means that the cost of repair is more than the vehicle is worth.)

In other words, because cars depreciate in value over time, your car may be worth less than what you owe. That could leave you with a big bill. Gap insurance covers the difference.

If you’re “underwater” or “upside down” on your auto loan, it’s a good idea to consider gap insurance. While “underwater” might sound dire, all it means is that the market value of the car is less than what you owe.

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.¹ However, there’s no single, objective source for a car’s value. Why? Because prices fluctuate with factors like industry developments and economic conditions. Check multiple sources to get a sense of your car’s worth.
2. To determine your loan balance, subtract what you’ve already paid toward the loan from the original total loan amount.
3. Compare the value of your car to your outstanding loan balance.
4. If the value of the car is less than loan balance, you’re underwater (this is also known as having negative equity).

In general, 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, according to the Insurance Information Institute.²

If you took advantage of a dealership incentive (for example, a low down payment with three months “free”), you’ll likely be underwater for several months after you purchase your vehicle.

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 $20,000, but the car is only worth $16,000.

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 $15,500. 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.

When you buy a new car, the dealership may offer to sell you gap insurance. However, buying this type of insurance through a dealer is typically more expensive than getting it through your auto insurer or a stand-alone gap insurance provider.

See if your insurance company offers gap insurance as an add-on to your current policy. Larger insurance companies like AAA, Liberty Mutual, Nationwide, Travelers, and USAA offer it. If you did buy this type of insurance from the dealer but want to switch to another provider, you may be able to remove it from your contract.

Keep in mind that most providers require you to have both collision and comprehensive coverage before you can purchase a gap policy. 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. And if you’re shopping around for insurance, look no further than our review of the best auto insurance companies.

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 exact cost of gap insurance 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.

Buying gap insurance through your auto insurer is often the cheapest route. Most companies require you to have collision and comprehensive coverage in order to get gap insurance. With most policies, gap insurance adds only about $20 to $40 to your annual premium, or a few dollars per month. If you’re unsure about your payments, check out our frequently asked questions on how much you should pay for car insurance.

Gap insurance is usually more expensive through a dealership or the lender that financed your loan. Through a lender, expect to pay an upfront flat fee of $500 to $700 — or the dealer/lender may include gap insurance in your loan, in which case you’ll pay interest.⁵

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

Most gap insurance policies do not cover the insurance deductible. For example, 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. That said, gap policies occasionally cover the deductible too.

Gap insurance does not cover missed loan payments or late fees either. If you refinance your auto loan, it usually voids your gap policy. In this case, you’ll need to buy a new gap policy.

Gap policies only cover the total loss of a vehicle from accident or theft; this does not include losses of vehicles from mechanical issues like engine failures. It also doesn’t cover bodily injuries, medical expenses, lost wages, or funeral costs.

Collision insurance covers any damages the vehicle sustains while in motion, such as in a car accident. Comprehensive coverage pays for vehicle damages not related to driving. This includes theft, vandalism, falling objects, and weather-related damage.

If you lose your vehicle in one of these situations, collision or comprehensive insurance will pay for the value of your car at the time of the incident. Gap insurance, on the other hand, covers the difference between the collision/comprehensive insurance payout and your remaining loan balance.

Like any purchase, gap insurance has its pros and cons.

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.” The most notable difference is that if you buy a used car, you may be able to purchase loan/lease payoff insurance. (You often can’t buy gap insurance for a used car.) Loan/lease payoff insurance typically pays 25 percent of the actual cash vehicle of the vehicle.

For example, let’s say you paid $30,000 for your truck, and someone steals it a month later. In that time, the value of the truck depreciated to $24,000. Loan/lease payoff insurance will pay you 25 percent of the truck’s value, which is $6,000. 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

If something happens to your new vehicle, there’s a good chance you’ll want to replace it. New car replacement insurance helps you pay for a new car (minus the deducible) to replace your former vehicle. 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. To learn more, read our FAQs below. If you found this article helpful, check out more of our articles about car insurance.