What Is Gap Insurance and How Does It Work?

Gap coverage offers drivers one more way to protect themselves against financial loss. When a totaled car is worth less than what is owed, gap insurance fills the void, saving the driver what may be a huge out-of-pocket expense. Here, we provide everything you need to know about gap insurance, how it works, when you need it, and when you don't.

What is gap insurance?

Guaranteed asset protection (gap) insurance can be added alongside a regular auto insurance policy. It is designed to protect drivers who owe more on a car than it's worth.

How does gap insurance work?

The moment a driver leaves the parking lot of a car dealership, the value of the vehicle begins to decline. Most cars lose 20% of their value over the first year. So a car purchased today for $40,000 is likely to be worth around $32,000 a year from now. That can be a problem for a driver who totals a vehicle that is no longer worth as much as they owe on it.

How does gap insurance work? Let's say a driver is in an accident one year after borrowing $40,000 to buy a car. The car is totaled, and as the insurance company does when a car is totaled, it pays the driver the Blue Book value of the car. In this case -- because the car has been on the road for a year -- the value has fallen to $32,000.

When they bought the car, the driver put no money down, and since their interest rate was 6%, they took out an 84-month loan to keep the payments low. The problem is, they still owe nearly $35,000 on the car -- $3,000 more than the insurance company is willing to reimburse them.

When a car is totaled, all proceeds from the insurance company go to the lender to pay off the vehicle (if there is any money still owed on the car). In this case, the insurance company would cover $32,000 and the driver would be on the hook for the additional $3,000.

If the driver has gap insurance, that means that the insurer will pay the entire $35,000.

Gap insurance for leased cars

It's as important to carry gap insurance on a leased vehicle as on any other financed car. If a leased vehicle is totaled, lease gap insurance covers the difference between its value and the amount still owed on the lease agreement. Just as the driver of a leased car must carry standard auto insurance, it makes sense to carry gap coverage.

What does car gap insurance cover?

The difference

Car gap insurance covers the difference between how much a driver owes on a vehicle and its depreciated value.

All kinds of losses

Gap coverage does not just protect the driver against car accidents. If a car is stolen, destroyed in a fire, thrown across a field in a tornado, or in any other way totaled, car gap insurance fills the void between what is owed and how much the vehicle is worth.

Who needs gap insurance?

Gap insurance is particularly important for drivers who:

• Owe more on their vehicle than its Blue Book value. Unless a driver is willing to pay out of pocket for the difference between what their car is worth and how much they owe, gap insurance is a necessity.
• Are required by their lender or lease provider to carry car gap insurance along with regular auto insurance coverage.

How much is gap insurance?

Car gap insurance tends to be inexpensive. In fact, a driver may be able to add gap coverage to their auto policy for as little as $3 per month, or $36 per year. That said, the amount a driver pays for gap coverage depends on factors such as:

• The current value of the vehicle
• The state in which they reside
• Previous car insurance claims

Is gap insurance worth it?

Imagine that a driver totaled their car. The difference between the amount the driver still owes on the vehicle and how much it has depreciated in value is $7,500. Without gap insurance, the driver must pull the $7,500 difference out of their bank account or find another way to cover the loss. For as little as $3 per month, that same driver could have protected their assets by paying for gap coverage.

When does gap insurance not pay?

Gap coverage does not pay out in every situation. Here are some examples of when gap insurance does not pay.

• Gap coverage won't typically pay out if a vehicle was totaled due to the driver being under the influence.
• Gap insurance does not pay out if the total loss claim is denied. For example, a driver with gap insurance may claim that their car was stolen, hoping that insurance will cover the claim. If the insurer suspects the driver of hiding the car somewhere and denies the claim, gap will not pay out.
• Gap does not fully pay out if the driver is behind on car payments. Instead, late car payments and fees are deducted from the amount that would have been sent to the driver.
• Gap does not cover medical bills or property damage associated with the accident that caused the vehicle to be totaled. In other words, gap coverage is strictly intended to pay the difference between how much is owed and how much the vehicle is worth.

How can you buy gap insurance?

Gap insurance can be added when a driver finances a car or signs a lease (although some lease companies automatically add it in, so be sure to ask). Accepting gap coverage through a dealership is likely the most expensive option, as dealers typically charge from $400 to $600 for their version of gap coverage.

A driver also has the option of purchasing gap insurance through their lender, although according to United Policyholders, lenders charge a flat fee of $500 to $700 for gap coverage.

Finally, a driver can add gap coverage to their existing auto insurance coverage for as little as $36 per year.

Car insurance companies that provide gap coverage

Gap insurance is not at all unusual and can be purchased through some of the best auto insurance companies, including:

• American Family Auto
• USAA (through its Car Replacement Assistance)
• Liberty Mutual
• Nationwide
• Allstate
• Esurance (owned by Allstate)
• Progressive
• AAA
• Travelers

Gap insurance through your dealership or lender

A driver's best option is almost always to purchase gap coverage alongside auto insurance coverage. Let's say a dealership charges the mid-range price of $500 for a policy, and a lender charges the mid-range price of $600.

Now, let's say the driver only needed gap coverage for four years (in other words, they owe more on the car than it's worth for four years). That means they paid somewhere between $125 and $150 per year for gap coverage.

If the same driver is able to add a premium of less than $50 per year to the typical cost of car insurance, it's easy to see how the gap insurance cost through an auto insurer makes the most sense.

What are alternatives to gap insurance?

Unless a lender or lease company requires gap coverage, a driver can look at other options.

Savings account

One alternative to car gap insurance is to have enough put away in an emergency savings account to pay the difference between how much is owed on a vehicle and what it's worth.

Loan/lease coverage

While some gap insurance companies use the terms "gap insurance" and "loan/lease payoff" interchangeably, they are two different insurance products. Loan/lease coverage is similar to gap coverage, but instead of filling the entire gap between what a driver owes on a totaled car and how much that vehicle is worth, loan/lease coverage pays up to 25% of a car's actual cash value (ACV).

For example, if a driver totals their vehicle and it's worth $20,000, loan/lease coverage will pay up to $5,000. If the balance owed on the vehicle was $5,000 or less, loan/lease coverage makes sense.

Now, let's say that the driver has a remaining balance of $15,000 on that car. In that case, loan/lease coverage would still leave the driver with a $10,000 shortfall. Because the driver still owes so much on their vehicle, gap insurance would have been the best option.

For drivers who want the added benefit of knowing that they are fully covered in the event their vehicle is totaled, nothing works better than gap insurance.