What Is Gap Insurance and Do I Need It?

The minute you drive off the dealer’s lot with a new car, it begins to depreciate. According to the Insurance Information Institute, most automobiles depreciate by 20% their first year on the road.

In the event you file a car insurance claim, collision and comprehensive auto policies only pay up to the actual cash value of your car. If you buy a new car for $30,000 and total it in the first year, the insurance company will only pay what it’s worth on the market; let’s say $24,000. If you total the vehicle three years into ownership, it will have depreciated even more, so the insurance company may only pay a claim equal to half its original purchase price.

Unfortunately, the scenario only gets worse. If you took out a $28,000 loan for the car and total it the first year, the amount of money the insurance company pays on your claim will not be enough to pay off the loan. The situation isn’t as dire as it might seem because gap insurance can help cover the difference between the amount of your claim check and the amount you owe the lender.

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      Gap insurance covers the difference between your car’s current market value and the amount you owe a lender. So, if your car has a depreciated value of $28,000 when it’s totaled, and the insurance company pays $24,000 on your claim, a gap coverage policy will pay off the amount of money you still owe the lender.

      [ Read: The Best Car Insurance Companies of 2020 ]

      What is gap insurance? 

      As the name applies, gap insurance pays the “gap,” or difference, between how much you owe on your car loan or lease and the amount your car insurance company pays you for your vehicle in the event the vehicle is totaled and cannot be repaired. Because your vehicle value depreciates rapidly, the amount you receive in the event of a claim may not be enough to pay off your car loan or lease. Therefore, gap insurance is good to have if you financed your new vehicle for 60 months or longer, didn’t put down a large down payment or leased a vehicle.

      How does gap insurance work?

      Gap insurance kicks in when you file a claim on your vehicle following an accident or other incident, and the car is considered “totalled,” or beyond repair. The car insurance adjuster will inspect the car and determine how much the car insurance company will pay for the car’s actual value. If that amount is less than your remaining car loan or lease amount, the gap insurance will cover the difference so you can pay off your loan or lease.

      [ Read: Steps to Switch Car Insurance Companies ]

      How to buy gap insurance

      If you lease your car, the leasing company may include gap insurance in the lease agreement. In some cases, your collision and comprehensive policies may include gap insurance. It’s important to know if you already have the coverage. If you’re not sure, read your policy’s fine print or call your agent for more information.

      You can buy gap insurance through an auto dealership, a car insurance company or lender. Typically, large carriers such as Allstate, Esurance, Nationwide and State Farm sell gap insurance as an add-on to your collision and comprehensive coverages. Some companies market their gap insurance using a catchy name. For instance, State Farm markets its gap insurance as Payoff Protector.

      If you want gap insurance, check if your preferred insurance company offers the coverage because some don’t. For instance, Geico, one of the nation’s largest car insurance companies, doesn’t offer gap insurance.

      Because automobiles start depreciating the moment the salesperson hands you the keys, it’s best to buy the coverage immediately for all leased and most financed vehicles.

      How much does gap insurance cost?

      Add-on coverages increase the cost of your car insurance, however, gap coverage actually is quite affordable and won’t raise your rates too much. In fact, gap insurance usually costs around $20 per year, according to the Insurance Information Institute. Although car dealers often offer gap insurance to their customers as part of the financing on the car loan or lease, auto insurance companies often offer the cheapest car insurance rates for gap insurance. It’s important to shop around with at least three different car insurance companies to find the best rates for you.

      Should I get gap insurance?

      State laws don’t require you to purchase gap insurance. However, the coverage is reasonably priced, so it makes good financial sense to buy it in most cases.

      When is gap insurance worth it?

      Gap insurance is also important if you’re in certain situations.

      If you lease a vehicle, the leasing company probably will require you to buy gap insurance and may include it in your lease agreement. Typically, leased vehicles are new, but because automobiles depreciate rapidly, the leasing company will require you to carry liability, collision, comprehensive and gap insurance to fully protect its property.

      If you make a down payment of less than 20% of the purchase price, consider buying gap insurance.If you don’t make at least a 20% down payment, the car’s actual cash value may be lower than the amount you owe the lender the minute you drive away from the dealership.

      The high sticker prices of today’s cars make long finance terms attractive to many automobile owners. It’s easier to afford payments on a 60-month loan than it is a 24-month loan. But each payment you make goes toward principal and interest. If you finance your car for more than two years, you need gap insurance because the difference between your car’s actual cash value and the amount you owe the lender will occur quickly, sometimes in the first year of ownership.

      Before buying any vehicle, check Kelley Blue Book to see the resale history for your type of car. Some automobile makes and models depreciate faster than others do and are more difficult to resell. Used cars have a retail value and a trade-in value. Usually, the trade-in value is lower than the retail value. If you finance a vehicle that has a poor resale history or one that depreciates quickly, you need gap insurance.

      When is gap insurance not worth it?

      Your lease terms may require you to carry gap insurance as long as you have the automobile. But if you finance a car, you don’t need to carry gap insurance for the entire loan term. When the amount you owe dips below the actual cash value of the vehicle, you can discontinue gap insurance coverage. And if you pay cash for an automobile, you don’t need gap insurance.

      How to get cheap car insurance?

      To find the cheapest car insurance for you, you need to talk with at least three different car insurance companies to get personalized quotes for you. Car insurance companies evaluate a number of factors to determine your rate, and each company evaluates these factors differently. Factors include age, where you live, type of vehicle you drive and your driving history. Therefore, talk with each company on the same day, provide the same personal information and ask for rates on the same type of coverage so you can get a true comparison of the cheapest rates for you.

      Although most car dealerships offer gap insurance coverage when financing your vehicle, this gap coverage often is more expensive than coverage offered through car insurance companies. Shopping for gap insurance as part of your car insurance policy before purchasing a car is a great idea so you know how the car insurance companies’ rates compare to those at the car dealership.

      Most car insurance companies offer gap insurance as part of their offerings, including Allstate, Nationwide, State Farm and Progressive. Talk with your local car insurance agent to find out if he or she offers gap insurance.

      [Read: What Are the Consequences of Driving Without Insurance?]

      We welcome your feedback on this article. Contact us at inquiries@thesimpledollar.com with comments or questions.

      Reviewed by

      • Nashalie Addarich
        Nashalie Addarich
        Insurance Editor

        Nasha Addarich is an editor at The Simple Dollar and a former attorney who specializes in home insurance, auto insurance, life insurance, and savings. She is a former contributing editor to Reviews.com.