What Is Gap Insurance?

If you have a car loan, this supplemental insurance is definitely worth considering.

Written by Rafael Bernard / January 28, 2022

Quick Bites

  • Gap insurance covers the balance between the actual value of a car minus any outstanding loan amount in the event of an accident.
  • Car dealerships offer gap insurance but charge more than traditional insurance companies.
  • Gap insurance is for car owners who financed the purchase of their auto with a loan. If you paid in cash, you don’t need gap insurance.
  • Premiums tend to be lowest right when you purchase your vehicle. That’s also usually when it’s easiest to qualify.

When a catastrophe happens, the last thing you want to be worrying about is money. Insurance can take that worry off your plate so you can focus on your health and family following an accident or other incident.

Insurance products are great for helping manage life’s big risks. While sometimes we can’t avoid pitfalls that occur in day-to-day life, there are options out there to mitigate the financial impacts of unfortunate events like car crashes.

There are all sorts of car insurance products available, so it’s important to assess your personal driving situation to figure out what you need to help protect your car, savings and passengers.

Gap insurance, a product that helps protect drivers in case of a crash, can be an efficient form of auto insurance to complement your comprehensive risk management plan.

Inside this article

  1. What is gap insurance?
  2. Example of gap coverage
  3. Who should buy gap insurance?
  4. How much does it cost?
  5. How to get gap insurance

What is gap insurance?

If your car is stolen or totaled, gap insurance can cover the remaining balance on your auto loan, if the value of your car is insufficient. Typically, cars depreciate in value as soon as you purchase them, so if you make only a small down payment at the time of purchase, or have a long loan duration, it is quite conceivable that your car can end up worth less than the loan you got to finance it.

Following an accident, you may make an insurance claim and find out that the actual cash value (ACV) of your car at the time of the accident is less than the remaining balance on your loan. In this situation you’ll likely wish you had bought gap insurance when you purchased your car. Otherwise, you will have the unhappy surprise of discovering your standard car insurance isn’t enough to manage the financial risk of owning a car. You will have to pay out of pocket, possibly thousands of dollars, just to meet the remaining loan on a car that no longer exists.

Example of gap insurance coverage

Let’s say you were to finance a new car for $18,000, but after a few years of driving, it is now worth only $12,000. If your car gets totaled in a crash, standard car insurance may pay up to the ACV of your car ($12,000), after your deductible. If the remaining balance on your loan is $13,000, you will have to come up with the $1,000 to meet your remaining balance.

Who should buy gap insurance?

Gap insurance is only for car owners who financed the purchase of their auto with a loan. If you paid for your car in cash, there is no reason to consider gap insurance.

Some drivers with auto debt are more at risk than others of being in a situation where their ACV is less than the outstanding balance on their car loan. Below is a checklist from the Insurance Information Institute of when gap insurance is a good idea. If one of these criteria applies to you, you should consider doing more research on whether gap insurance is right for you:

  • You made a down payment lower than 20%

  • The term of your loan is greater than 60 months

  • You are leasing a vehicle

  • Your car model is the type that generally depreciates quickly

  • You rolled over negative equity from a previous car loan into your current loan. Negative equity is when you trade in an old car for a new one, but the balance on the loan is greater than the ACV of your old car. This negative equity can be managed several ways by the dealer, one of which is by rolling it over to the loan on your new car

Tip: Once you pay off your loan, don’t forget to cancel your gap insurance. You’d be surprised how often people mistakenly keep paying insurance premiums they no longer need.

One note about adding another payment to your monthly bills: A lot of us are on a pretty tight budget. Let’s face it, with all our competing priorities from gym memberships, phone and tuition bills, and family vacations, it can be tricky to make room for new expenses, especially for extra car insurance. But the alternative of not buying gap insurance and then having to come up with possibly thousand dollars to cover your loan balance could upend your budget completely or even deplete your emergency savings fund. That’s why the smart money move when it comes to insurance is to acquire it when the premiums are low—in the case of gap insurance, right when you purchase your vehicle.

How much does it cost?

The good news is that gap insurance is often relatively inexpensive compared with many other insurance products. According to the Insurance Information Institute, it’s not uncommon for the premium to be $20 a year (though how much your premium will cost depends on your individual situation). If you try buying gap insurance years or even a few months after buying your car, you may find it difficult to qualify for a policy.

How to get gap insurance

There are several ways to seek out gap insurance, but in general it’s easier to qualify when your car is brand-new, at the time of purchase. So do your due diligence by calling a few insurers, such as Progressive, Allstate or Nationwide before your purchase, or at the very least soon thereafter.

Car dealerships also offer gap insurance to their customers, but their policies can often be pricer than those offered by insurers.

About the Author

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Rafael Bernard

Rafael Bernard, MSFP, CFP®, is a CERTIFIED FINANCIAL PLANNER™ practitioner and personal finance editor at Decisionary Media who specializes in financial therapy, which combines traditional financial planning with a therapeutic approach.

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