What Is Gap Insurance?
Gap insurance, also known as “guaranteed auto protection” or “loan/lease gap coverage,” is a type of auto insurance that covers the “gap” between what you owe on your car loan or lease and the actual cash value of the vehicle if it’s totaled or stolen.
When you finance or lease a new car, the vehicle starts depreciating in value the moment you drive it off the lot.
However, the amount you owe on the loan doesn’t drop at the same rate. Gap insurance helps pay the difference if you’re in an accident and the insurance payout is less than the outstanding loan or lease balance.
For example, say you owe $25,000 on your car loan, but your vehicle is only worth $20,000 when it’s totaled.
The standard collision coverage would only pay the vehicle’s $20,000 cash value, leaving you to pay the remaining $5,000 out of pocket to settle the loan.
Gap insurance would cover that $5,000 “gap” so you don’t have an outstanding loan balance on a car you can no longer drive.
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When Do You Need Gap Insurance?
Gap insurance is typically recommended in situations where you owe more on your car loan than the car is currently worth.
This “gap” often occurs with new cars, which can depreciate rapidly, or when you finance a vehicle with a small down payment or over an extended loan term.
Gap coverage is especially valuable if you:
- Finance the purchase of a new vehicle
- Lease a new vehicle
- Make a small down payment (less than 20%)
- Finance over a longer loan term (e.g. 6+ years)
- Roll negative equity from an old loan into a new one
Even if your car is just a few years old, you may benefit from gap insurance if you owe significantly more than the car’s current market value.
This situation can arise after taking out a long-term loan or rolling over negative equity into a new loan.
Overall, gap insurance provides important financial protection if your car is totaled or stolen and you owe more than the car’s depreciated value.
Without it, you could be stuck paying off an outstanding loan balance on a car you can no longer drive.
How Gap Insurance Works
Gap insurance covers the “gap” between what you owe on your car loan or lease and the actual cash value of your vehicle if it’s totaled or stolen.
When you make a claim, the regular auto insurance policy pays out the car’s actual cash value at the time of the incident.
Gap insurance then covers the remaining balance on your loan or lease.
The gap insurance claims process typically works like this:
- File Claim: You file a claim with your auto insurance provider after your car is totaled or stolen.
- Assess Value: Your insurer determines the car’s actual cash value based on factors like age, mileage, condition, and market prices for similar vehicles.
- Pay Out: Your insurer pays you the cash value amount.
- Pay Lender: You pay the remaining loan/lease balance to your lender using the insurance payout.
- Gap Covers Rest: Gap insurance covers the “gap” or difference between the cash value and the outstanding loan/lease amount.
Gap coverage is usually limited to 25% above the vehicle’s cash value, with a maximum cap around $50,000.
So if you owe $25,000 but your car is worth $20,000 at the time of loss, gap insurance would cover the $5,000 difference.
Gap Insurance for New Cars
Gap insurance is often recommended for new cars because they tend to depreciate rapidly in the first few years of ownership.
The moment you drive a new car off the dealer’s lot, its value can drop by as much as 20-30%.
This depreciation continues at a faster rate in the first few years compared to later years.
If your new car is totaled or stolen soon after purchase, the insurance payout from a standard auto policy will only cover the car’s depreciated value at that time.
However, you may still owe a significant amount on the loan or lease if you made a small down payment or rolled over negative equity from a previous car.
Gap insurance helps bridge this “gap” between what your insurer pays and the remaining balance on your loan or lease.
With a new car’s value dropping so quickly, gap coverage provides valuable protection during the early years of ownership when the potential gap between the car’s value and loan balance is at its highest.
This safeguards you from having to pay off a loan for a car you can no longer drive. For this reason, many lenders require gap insurance when financing a new vehicle purchase.
Gap Insurance for Used Cars
Gap insurance can be beneficial for used cars, especially if you have a loan or lease with a significant balance remaining.
As a vehicle depreciates, the amount you owe on the loan can exceed the car’s actual cash value (ACV).
In the event of a total loss, your standard auto insurance will only cover the ACV, leaving you responsible for paying off the loan balance out-of-pocket.
When considering gap insurance for a used car, the vehicle’s age and the remaining loan amount are crucial factors.
Generally, the older the car, the less valuable it becomes, and the faster it depreciates.
If you have a substantial loan balance on an older used car, gap insurance can provide valuable protection against potential financial loss.
Additionally, the loan amount plays a role. If you have a small loan balance on a used car, the cost of gap insurance may not be justifiable, as the potential financial exposure is relatively low.
However, if you have a significant loan amount, gap insurance can be a wise investment to safeguard against potential financial hardship in the event of a total loss.
It’s essential to evaluate your specific circumstances, including the car’s age, condition, and remaining loan balance, to determine if gap insurance is a worthwhile investment for your used car.
Consulting with your insurance provider or lender can help you make an informed decision based on your individual needs and financial situation.
Gap Insurance and Car Leases
Gap insurance plays a crucial role when leasing a vehicle. Most leasing companies require lessees to carry gap coverage for the duration of the lease term.
This is because you don’t actually own the leased car – the leasing company retains ownership.
If the vehicle is totaled or stolen, you would still be responsible for the remaining lease payments, which can amount to thousands of dollars.
Gap insurance bridges this “gap” between what your regular auto insurance will cover and the outstanding lease balance.
It ensures you won’t have to pay out-of-pocket for a vehicle you can no longer use.
Leasing companies mandate gap coverage to protect their financial interests and mitigate potential losses.
When leasing a new vehicle, gap insurance is typically included in the lease agreement or offered as an add-on product.
The costs are either rolled into your monthly payments or paid upfront as a one-time fee.
Failing to maintain gap coverage during your lease term could result in penalties or even early termination of the lease.
It’s essential to carefully review the gap insurance requirements outlined in your lease contract.
Some leasing companies may have specific coverage limits or deductible amounts you must meet.
Understanding these terms can help you make an informed decision and avoid potential complications down the line.
Costs of Gap Insurance
Gap insurance typically costs between $20 and $40 per year when purchased from an auto insurance company.
However, the exact cost can vary based on several factors:
Vehicle Value: More expensive vehicles generally have higher gap insurance premiums since the potential gap between the loan/lease amount and market value is larger.
Coverage Length: Longer coverage terms, such as 5-7 years for new cars, will result in higher total costs compared to shorter terms like 2-3 years for used vehicles.
Deductible Amount: Some gap policies have deductibles, usually $500 or higher. Lower deductibles mean higher premiums.
Bundling Discounts: Many insurers offer discounts of 10-25% when gap coverage is bundled with other policies like collision and comprehensive.
Lender/Dealer Fees: When purchased through a lender or dealer, gap insurance fees are often rolled into the financing and can range from $500 to $1000 over the life of the loan.
The key is to shop around and compare quotes from multiple insurers and lenders. Gap coverage is relatively inexpensive when purchased separately but can add up substantially when folded into a car loan.
Gap Insurance from Car Insurers
Many major car insurance companies offer gap insurance policies that you can add to your existing auto coverage.
Insurers like Geico, Progressive, Nationwide, and Farmers all provide gap coverage options.
Typically, you’ll pay an additional annual premium on top of your regular car insurance rates to carry gap protection.
Geico’s gap coverage comes with a small deductible, usually around $50.
Their gap policies cover up to 25% more than your car’s actual cash value to make up the “gap” amount you may owe after an insurance payout.
Progressive’s gap insurance has no deductible and may refund some of your gap premium if you don’t need to use the coverage before dropping it.
Nationwide offers gap coverage for both new and used cars less than two model years old. Their gap plans have no deductible and no age requirements for the insured driver.
Farmers also provides gap insurance with flexible terms – you can purchase coverage for up to 84 months after buying a new vehicle.
When shopping for gap insurance through your auto insurer, compare premium costs, deductibles, vehicle age restrictions, and term lengths.
Many insurers pro-rate gap premiums so you pay less as your loan balance decreases over time.
Taking the time to assess each company’s gap offering can help you find the right fit.
Gap Insurance from Lenders/Dealers
When you finance a new or used car through a lender or dealership, they will likely offer you the option to purchase gap insurance coverage.
This is a convenient way to get gap insurance bundled into your auto loan or lease agreement.
Lenders and dealers make gap insurance available because they want to protect their financial interests in the vehicle you are financing.
If your car is totaled or stolen, gap coverage ensures the lender or dealer gets paid the outstanding loan balance, even if it exceeds the car’s depreciated value.
Gap insurance policies from lenders and dealers can be more expensive than purchasing coverage from your auto insurance company.
However, the cost is usually just rolled into your monthly loan payments. This makes gap coverage more affordable by spreading out the premiums over the life of the loan.
If you decide to buy gap insurance through the lender or dealer, be sure to read the policy details carefully.
Understand what is and isn’t covered, and verify that the coverage amount matches the total financing on the vehicle.
Dealers sometimes try to make extra profit by overpricing gap policies, so shop around if possible.
Signs You May Need Gap Coverage
There are a few key signs that you may be “upside down” or owe more on your car loan than your vehicle is worth, making gap insurance coverage worth considering:
Longer Loan Terms: Cars depreciate quickly, so if you took out a longer loan term (e.g. 6+ years), you’re at higher risk of the loan balance exceeding the car’s value for an extended period.
Low Down Payment: A smaller down payment means more of your loan is subject to rapid depreciation in the first year of ownership. Putting down 10% or less increases your chances of going upside down.
High Interest Rates: Higher interest rates cause your principal to be paid off more slowly, keeping more of the loan balance exposed to potential gaps between what you owe and the car’s value.
New Car with High Depreciation: New cars can lose 20% or more of their value in the first year alone. If your new car is totaled soon after purchase, gap insurance prevents you from having to pay off a large remaining loan balance.
Negative Equity from Previous Loan: If you rolled over negative equity from your previous car loan into a new loan, you start off already upside down on your current loan.
Long Commutes or High Mileage: Cars driven more miles per year than average depreciate faster, increasing the likelihood of becoming upside down on the loan.
If any of these situations apply to your car purchase, gap insurance can provide valuable financial protection against potential deficiency balances.
Alternatives to Gap Insurance
If you don’t want to purchase gap insurance, there are a few alternatives to consider that can help protect you from ending up upside-down on your auto loan:
- Make a larger down payment: By putting more money down upfront when purchasing a vehicle, you reduce the amount you need to finance. This decreases the risk of your loan balance exceeding the car’s value early on.
- Choose a shorter loan term: Longer loan terms (e.g., 72 or 84 months) increase the likelihood of becoming upside-down because cars depreciate quickly in the first few years. Opt for a shorter loan term, like 36 or 48 months, to pay off the loan faster before significant depreciation occurs.
- Avoid rolling over negative equity: If you owe money on your current car when trading it in, don’t roll that negative equity into your new auto loan. This compounds the upside-down situation from the start.
- Buy a used car: Used cars generally hold their value better than new cars, which lose a significant portion of their value as soon as you drive off the lot. Buying a slightly used vehicle can help prevent going upside-down on your loan.
- Make higher monthly payments: If possible, pay more than the minimum monthly payment to pay down the principal faster. This reduces the amount of time you’re at risk of being upside-down on the loan.
While these alternatives don’t provide the same level of protection as gap insurance, they can help minimize the chances of ending up with negative equity in your vehicle.
Ultimately, it’s essential to carefully consider your financial situation and potential risks before deciding whether gap insurance or an alternative approach is best for you.
Gap Insurance Requirements
Many lenders and leasing companies require you to carry gap insurance when financing or leasing a new vehicle.
This protects their investment in case the vehicle is totaled or stolen before you’ve paid off a significant portion of the loan or lease.
For new car loans, gap coverage is typically mandated if you’re putting down less than 20% as a down payment.
Leasing companies almost universally require gap insurance since you don’t build any equity in a leased vehicle.
The gap insurance requirement helps safeguard the lender or lessor against significant financial losses due to the vehicle’s rapid depreciation in its first few years.
Without gap coverage, you could find yourself still owing thousands after a total loss payout from your standard insurance policy.
If you’re taking out a loan or starting a lease, carefully review the contract’s terms and conditions regarding gap insurance.
Failure to maintain the required coverage could put you in breach of contract and lead to penalties or even repossession of the vehicle.
Pros and Cons of Gap Insurance
Pros of Gap Insurance
- Covers the “gap”: Gap insurance protects you from having to pay out of pocket for the difference between your car’s actual cash value and the remaining balance on your loan or lease if your vehicle is totaled or stolen. This can save you thousands of dollars.
- Provides peace of mind: Knowing you’re covered for the gap amount can give you peace of mind, especially if you have a loan or lease on a vehicle that depreciates quickly.
- Helps rebuild credit: If your car is totaled and you can’t cover the gap, your lender may send your account to collections, damaging your credit score. Gap insurance helps avoid this scenario.
- Required for some leases: Many auto leasing companies require you to carry gap insurance, so it’s a necessary expense if you want to lease.
Cons of Gap Insurance
- Added upfront cost: Gap insurance adds to the overall cost of your auto loan or lease, either as a one-time fee rolled into your financing or as an annual premium.
- Diminishing benefit: The benefit of gap insurance declines as you pay off your loan or lease, since the gap amount shrinks over time.
- Potentially unnecessary: If you made a large down payment or your car holds its value well, you may not need gap coverage since the gap amount is small.
- Overlapping coverage: Some auto insurance companies include gap protection with certain policies, so you could be doubling up on coverage needlessly.
