If your vehicle gets totaled or stolen before you've paid off your loan, you could find yourself owing thousands more than the car is worth. Gap insurance is designed to protect you from this financial shortfall, but is it right for your situation?
What is Gap Insurance?
Gap insurance is an optional auto policy that covers the difference between your vehicle's actual value and what you owe on it. Also known as guaranteed asset protection, gap insurance can prevent you from paying high out-of-pocket costs after a car accident or theft.
How Does Gap Insurance Work?
Gap insurance covers the "gap" between what you owe on your car loan or lease and what your car is worth if it gets totaled or stolen.
Here's why that matters: if your car is worth $15,000 but you still owe $20,000 on your loan, gap insurance pays that $5,000 difference so you're not stuck paying for a car you no longer have.
Gap Insurance vs. Gap Waiver
You might also encounter something called a "gap waiver" when shopping for a vehicle. "Many dealerships, lenders, and leasing companies offer a gap waiver as an alternative to gap insurance," says Kevin Kramer, chief operating officer at Ignition Dealer Services.
The key distinction is that a gap waiver is a contractual agreement that cancels the remaining loan balance if the vehicle is declared a total loss," explains Kramer.
Unlike gap insurance, a gap waiver is not an insurance policy but rather a waiver of your outstanding debt. Regardless of whether you choose gap insurance or a gap waiver, you get the same financial protection.
When Do You Need Gap Insurance?
While gap insurance isn't required to drive legally, it can be beneficial in several situations, including:
- You made a low down payment on your vehicle: If you only put a small amount of money down when you financed your vehicle, gap insurance can be a smart investment. "You're more likely to owe more than the car's value early in the loan term, putting you at greater financial risk if the car is totaled or stolen," said Kramer.
- You have a long loan term: Financing a car over a long period, such as 60, 72, or even 84 months, often results in slower equity build-up, increasing the chance that you will be "upside down" on your loan. In this case, gap insurance is a smart choice.
- You lease your car: The balance you'll owe after your car gets totaled or after car theft will likely exceed its market value throughout much of the lease term. As a result, gap insurance is usually required for car leases.
- Your car depreciates quickly: Most cars lose value as soon as you drive them off the lot. However, if you choose an economy vehicle or another option with a particularly high depreciation rate, gap coverage can protect you from the value shortfall and provide peace of mind.
When You Might Not Need Gap Insurance
Gap insurance, which is often referred to as loan and lease insurance, is usually optional. There are several scenarios where it's not worth the cost, including:
- You made a large down payment: If you've financed your vehicle with a significant down payment, typically 20% or more, the risk of owing more than the car's value is much lower, meaning gap insurance doesn't make sense.
- Your loan term is short: When you finance a car with a short term of 36 months or less, you reduce your risk of a substantial value gap. In this scenario, you can skip gap insurance with confidence.
- Your vehicle holds its value: If you buy a car that retains value fairly well, such as certain SUVs or trucks, you might have less need for gap coverage. Gap insurance is better suited for vehicles that depreciate rapidly.
- Your car is paid off: Gap insurance is unnecessary for a car that's nearly paid off. The financial exposure is minimal, making this coverage unnecessary.
Pros and Cons of Gap Insurance
As with any type of car insurance or other financial product, gap insurance comes with benefits and drawbacks to consider.
| Pros of Gap Insurance | Cons of Gap Insurance |
|---|---|
| Provides important financial protection against loan balance shortfalls | Some policies come with specific limits, exclusions, or fees that must be reviewed carefully |
| Brings peace of mind during the high-depreciation period of vehicle ownership | May not transfer if you refinance your vehicle loan, requiring new coverage |
| Typically inexpensive when bundled with a new loan or lease | Limited coverage scope with specific exclusions |
"Gap insurance typically does not cover late or deferred loan payments, nor does it cover prior repairs that were paid for by the primary insurer but were not completed," explains Kramer.
How to Get Gap Insurance
When shopping for gap insurance, consider these key factors:
- Timing: "The best time to invest in gap insurance is typically when you initially buy or lease a vehicle, maximizing protection when the risk of value loss is highest," explained Kramer.
- Dealership vs. insurance company: According to Melanie Musson, an auto insurance expert, insurance from the dealership could be overpriced. "Gap insurance from your insurance company is typically much cheaper. You should compare both options to determine which is best for your situation," she said.
- Current auto policy: Check your existing car insurance policy, as some companies offer affordable gap insurance add-ons.
- Read the fine print: Before you commit to coverage, carefully review what's covered, what's excluded, and whether payout caps apply.
Bottom Line: Is Gap Insurance Worth It?
Gap insurance can save you thousands of dollars if your car is totaled or stolen while you still owe more than it's worth. It's most valuable for drivers with small down payments, long loan terms, or leased vehicles. Shop around and compare prices from your insurance company with those of the dealership to get the best deal.
Frequently Asked Questions
What is the difference between gap insurance and collision insurance?
Gap insurance is designed to cover the difference between what you owe on your vehicle and what it’s worth after it gets totaled or stolen. Collision insurance helps pay for vehicle damages from car accidents, no matter who is at fault. Both types of insurance policies are optional.
How much does gap insurance cost?
Gap insurance is typically affordable and ranges from $50 to $250 per year. Factors like your location, whether you opt for a standalone policy or add-on, and the insurance company you choose can all impact premiums.
Can I cancel gap insurance?
Yes, most car insurance companies and dealerships will allow you to cancel a gap insurance policy and in some cases, collect a refund. Reach out to your gap insurance company for details on their cancellation policy.
