What Does Gap Insurance Cover?

Gap insurance covers the cost difference between the remaining value of your vehicle loan or lease and your car's actual cash value if your car is severely damaged, totaled or stolen.

Gap insurance coverage is an additional vehicle policy that tends to be more useful in the first few years of vehicle ownership, when you may owe more on your loan than your car is worth. And, while it may pay the "gap" between what you owe on a vehicle and what the car is actually worth, gap insurance will not cover any deductibles or costs associated with vehicle repairs and injuries as a result of an incident.

What is gap insurance?

Gap insurance is optional auto insurance coverage that pays off a vehicle loan in the event your car is totaled in an accident or stolen and never found and you owe more than what the car is worth. Essentially, it is added financial security and means you would be off the hook for any balance owed between the loan amount and the car's actual value if any severe and unfixable damage occurs.

How does gap insurance work?

Let's say your new car is deemed "totaled" and you owe $20,000 on your loan, but your auto insurance company assesses the value of your vehicle at $15,000. You now owe $5,000. Gap insurance will pay that $5,000 difference so you don't have to. However, what's considered a "total loss" varies by state and by auto insurance provider.

Standard auto insurance policies are designed to only cover the current market value of a vehicle if and when a claim is made. And that value depreciates over time. In fact, most vehicles' value decreases by 20% in the first year, according to the Insurance Information Institute. This means that if your car — which starts to depreciate once it leaves a dealer's lot — sustains significant damage or is totaled, your insurance company may assess its value at less than what you owe. That's where gap insurance comes in handy. It covers the cost for you.

When to get gap insurance

Gap insurance coverage makes the most sense when your vehicle loan balance is likely to exceed the actual value of the car. This usually occurs when:

1. You put little or no money down when you financed your car.
2. Your trade-in vehicle was less than what you owe on your trade-in and that amount was added to your new car loan.
3. Your newly financed car has a low resale value.
4. You plan to rack up mileage on your car, which will impact your car's value quickly.
5. You've taken out a long-term car loan of 60 months or more.

Additionally, some insurance companies may require your vehicle to be brand-new in order for you to purchase gap insurance. This usually means that your vehicle is under 3 years old and that you are the original owner.

How to purchase gap insurance

Most dealers offer gap insurance for both leased and financed cars at the time of purchase, but rates and coverage vary considerably. The cost of gap insurance depends on the make and model of a vehicle and how fast it depreciates. It also varies by state and can be determined by your age and previous claims. If you purchase coverage at the time of financing or leasing through a dealership, you will likely pay a flat fee between $500 and $700, plus interest if it is added to your loan.

You can also get gap coverage after you buy your car through an auto insurance company on top of your regular policy. The average rate is considerably less, at around $60 a year, according to USA Today. Remember, though: Some insurers require your vehicle to be brand-new in order for you to purchase gap insurance and you must already have comprehensive and collision auto policies.

Is gap insurance coverage required?

No. Gap insurance isn't required by any insurer or state, but some leasing companies may require this coverage. Also, when purchasing a new car, some dealers may automatically add gap insurance to your car loan. However, you can decline this coverage.

Once you do get gap insurance, it applies for the duration of your policy, but you may not need coverage for the entire length of your loan. You can drop gap coverage once you owe less than what the car is worth.