What is gap insurance and do I need it?

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UPDATED: 2019-05-14T21:26:18.397Z
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A young couple reading over gap insurance paperwork with an agent.

Gap insurance is shorthand for “guaranteed auto protection” coverage, but it’s also an easy acronym to remember because it covers the “gap” between what is owed on a vehicle and what the payout amount would be if the vehicle was totaled. If you typically lease vehicles, or if you put only a small amount down on a new car and finance the rest, gap insurance could be very important coverage for you to have.

What is gap insurance?

Unlike real estate, the value of a car starts to depreciate as soon as you drive it off the lot. It’s estimated that within the first year, a car loses 20 percent of its original value. When you buy car insurance, the claim value depreciates along with the value of the car. So, if your car is in an accident and has to be written off, your car insurance will compensate you only what the car is worth at present (known as the actual cash value) and not what you paid for it when you bought it.

For a lot of people who then have to invest in a new car, this can be quite a loss. To help close the gap between the cost of a new car and the depreciated value that was covered by your car insurance is where gap insurance comes in. Gap insurance is a secondary insurance that you take out on your car for the very purpose of being reimbursed the full amount of a new car in case of an accident.

Gap insurance example

Gap insurance can often be best understood with an example. Here’s a scenario when gap insurance would come into play:

  • You owe $20,000 on your car loan
  • Your car has an actual cash value of $16,000 and you’re involved in a total loss accident
  • Your standard car insurance policy covers $15,500 and you pay your $500 deductible
  • Your gap insurance pays the $4,000 difference

Do I need gap insurance?

There are some instances when purchasing gap insurance is a very good idea. Here we break down those times when you should consider getting gap insurance:

Low down payment

If you make a down payment of less than 20 percent when buying a car, then what you end up paying on your loan could be more than what the car was originally worth. Combine this with the fact that the value of the car keeps depreciating with time and you could stand to lose a lot of money if you plan to trade in the car or it gets badly damaged in an accident. The gap insurance can cover all the difference so that you can comfortably invest in a new car if you opt to buy new.

Upside-down car trade

If you want to trade in your upside-down car — meaning you owe more on the loan than your car’s current worth — your loan amount will get added on to the new car by the dealership. The only way to get out of having an upside-down car loan is to pay the difference at the time of buying the new car. However, if paying the whole loan amount is not possible, then you could be in trouble if the new car gets totaled in an accident or stolen. The protection that gap insurance offers to cover these costs can be invaluable in the case of an upside-down car loan.

Long-term car loan

At some point during the duration of the car loan, the value of the car and the loan balance equal out. This is the break-even point for car owners with a car loan. With regular-term loans, the break-even point could occur within the first couple of years. However, with long-term loans, such as those with a duration of 60 months or more, the break-even point is much further in the future. If your car is badly damaged or stolen before you hit the break-even point, you could see yourself facing a considerable loss. Gap insurance is a good companion when you have taken a long-term loan.

Low resale value

Some cars simply have bad resale value. When it comes to cars with a bad resale value, then anything less than a down payment of about 25 percent will have your car upside-down in a year or so. Selling or trading the car will never make you enough to pay off your loan and have some left over, and, of course, if the car is damaged or stolen, you get a much lower compensation from your standard car insurance policy. Again, gap insurance would be a smart idea in a situation like this.

Many miles piled on

If you enjoy long drives or have to commute long distances regularly, then you should consider gap insurance. A car with many miles depreciates faster than the same make and model car without significant miles. So, while you might anticipate a 20 percent drop in value after a year, the actual sale value of the car after that period would be considerably less. For cars that are going to be driven over long distances a lot, gap insurance is a sensible choice.

What does gap insurance cover?

Before you buy gap insurance for your vehicle, it’s important to know what’s actually covered. Here are the areas that are usually covered by gap insurance. You should always check with your insurance provider first before buying a policy.

  • Theft: Most gap insurance policies will cover the difference left after you get reimbursed for a stolen vehicle. As mentioned earlier, your standard car insurance policy (if you have comprehensive insurance) will pay you the current market value and the gap insurance will pay the remaining amount to make up for what you initially paid for the car.
  • Complete damage: This is one of the most common reasons why people purchase gap insurance for their car. A car that’s totaled during an accident or by weather is typically covered by gap insurance.

Where can you buy gap insurance?

Most insurance companies that offer car insurance also offer gap insurance. In some cases, the car dealer themselves might offer you gap insurance, but it’s always better to do a bit of research before you dive in. Generally, car dealerships tend to be more expensive than car insurance companies when it comes to insurance policies.

The main points to remember when buying your gap insurance is to know for what purpose it’s intended and to make sure that the policy you are buying does cover that purpose. If you’re in search of a car insurance company to provide gap insurance, check out our car insurance rankings page.

The content on this site is offered only as a public service to the web community and does not constitute solicitation or provision of legal advice. This site should not be used as a substitute for obtaining legal advice from an insurance company or an attorney licensed or authorized to practice in your jurisdiction. You should always consult a suitably qualified attorney regarding any specific legal problem or matter. The comments and opinions expressed on this site are of the individual author and may not reflect the opinions of the insurance company or any individual attorney.

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