What Is Gap Insurance?

Displeased woman dialing for help after a car accident in the city.

A financed or leased car is a major financial obligation, and it's one that auto insurance is supposed to help protect. But in some cases, your auto insurance payout won't cover the full amount you still owe on the car if you're involved in a crash. That's where gap insurance comes in.

Gap (also called guaranteed asset protection) insurance is auto coverage that bridges the monetary gap between the value of your car and how much you owe on the car if it's heavily damaged, destroyed or stolen. Ride along as we explain how gap insurance works, who might need it and how you buy it.

How Does Gap Insurance Work?

Gap insurance can help you pay off your auto loan or lease if your new or used car is destroyed or seriously damaged in a crash or natural disaster (like a flood) or if it's stolen. Gap insurance applies only to cars that are already covered by two basic types of auto insurance: comprehensive and collision.

Let's say you wrecked your car and it would cost more to repair it than it's worth. A typical auto insurance policy would cover the actual cash value of your car. This refers to the depreciated value of your car—basically how much the car would have been worth to a buyer before the crash. Some cars depreciate faster than others, but expect a car to at least lose a chunk of its value the second you drive it off the dealer's lot and another 15% to 25% every year after that. Due to depreciation, you might wind up owing more on your loan or lease than your car insurance company would reimburse you for.

Here's an example of how gap insurance could work.

A few years ago, you took out a $35,000 loan for a new car. Since then, you've knocked down the balance on your loan to $30,000. One day, you're driving on a slick street and crash into a tree. You're OK, but your car isn't. The car has sustained so much damage that your insurance company declares it a total loss.

The insurer values your car at $25,000. After subtracting your $500 deductible, the insurance company pays you $24,500. That leaves you with a $5,500 gap between the insurance payment and the amount you still owe on your loan. Gap insurance should make up the $5,500 difference and pay off your car loan. Without gap insurance, you'd most likely have to cough up that $5,500 on your own.

Some of the items that gap insurance does not cover include:

  • Insurance deductibles (in most cases)
  • Lost wages
  • Medical expenses
  • Funeral costs
  • Rental car bills
  • Down payment for your next car
  • Extended warranties

Another thing to keep in mind is that gap insurance isn't available in every state.

When Does It Make Sense to Buy Gap Insurance?

Not everyone who buys a car needs gap insurance. That decision depends largely on your own situation and how much of a financial risk you're willing to take. There are cases where having gap insurance coverage makes sense and cases where it does not.

Here are six scenarios where it might make sense to buy gap insurance:

  1. You made a down payment of less than 20% of the car's purchase price.
  2. Your loan or lease period is longer than 60 months.
  3. You were upside down on your old car loan when you rolled it into a new loan. This is known as "negative equity."
  4. The covered car tends to depreciate more quickly than other makes and models do.
  5. You can't afford to cover the gap between the value of your car and the balance of your loan or lease.
  6. You drive at least 15,000 miles a year (due to more rapid depreciation and higher risk of a crash).

Gap Insurance for a Leased Car

In many cases, gap insurance isn't an option when you lease a car. Instead, it might be required. The cost of gap coverage might even be included in the price of your lease.

Typically, auto dealerships purchase what's known as a "master policy" from an insurance company that provides blanket coverage for all of its leased vehicles. You're then charged something called a "gap waiver." This waiver will automatically cover the difference between what the car is worth and your outstanding lease balance is if the car is totaled or stolen. Whoever leases the car to you normally requires that you carry comprehensive and collision coverage for the vehicle.

When Does It Not Make Sense to Buy Gap Insurance?

While there are a number of instances when buying gap insurance might be a smart move, there are also times when it probably wouldn't make sense. These include when you have:

  • Paid for the car upfront.
  • Made a down payment of at least 20% of the car's purchase price.
  • Saved enough cash to cover the gap between what your car is worth and how much you owe on it.

Where Can You Get Gap Insurance?

Fortunately, you have several options when it comes to buying gap insurance. Gap insurance is pretty inexpensive to begin with, but it's usually worth shopping around to make sure you get the best rate.

Start your search for gap insurance here:

  • Car insurance companies such as Allstate, Nationwide, Progressive and USAA sell gap insurance. Some insurers (such as GEICO) don't sell it, which can complicate matters if they're your current auto insurer. State Farm lets you add gap coverage to your auto insurance policy and it supplies gap coverage as part of every car loan it finances. Independent insurance agents, who represent a variety of insurers, also offer gap insurance.
  • Online insurance companies.
  • Auto dealerships.

How Much Does Gap Insurance Cost?

Gap insurance typically costs much less than traditional car insurance does. AAA estimates gap insurance usually costs about 5% of your annual car insurance premium. Trusted Choice, a network of independent insurance agents, says gap insurance averages about $40 a year.

A lender or auto dealership frequently charges higher rates for gap coverage than insurance companies do. If you tack gap coverage onto your regular auto insurance, it generally adds about $20 to your annual premium, according to the Insurance Information Institute.

Factors that affect the price of gap insurance include:

  • The insurer you pick
  • The actual cash value of the covered car
  • Your age
  • The state where you live
  • Your history of filing car insurance claims

The Bottom Line

Gap insurance can be a valuable addition to your car insurance coverage, particularly if your down payment covered less than 20% of the car's value, or you expect the car to depreciate quickly. In many cases, this extra coverage costs less than $3 a month.

If you do decide to buy gap insurance, compare rates offered by insurance companies, lenders and auto dealerships. Most of the time, you'll find that an insurance company charges the lowest rates. Remember that if you lease a car, you'll probably be required to pay for gap coverage, and that cost often will be folded into your monthly lease payments.

Not everyone needs gap insurance, though. For instance, you might have put down a hefty down payment or plan to quickly pay off your car loan. But for those who end up purchasing gap coverage, it can narrow the gap between financial concerns and financial confidence.

Learn More About Gap Insurance