Gap insurance is a supplemental auto policy that covers any difference between the insured value of a vehicle and the balance of the loan or lease that the owner must repay. If your vehicle is totaled or stolen before the loan on it is paid off, gap insurance will cover any difference between your auto insurance payout and the amount you owe on the vehicle.

Gap is an insurance industry acronym for "guaranteed auto protection".

Gap policies are available whether the vehicle is purchased or leased. But is gap insurance worth it? Yes, but only if and when you owe more money on that vehicle than the total that your comprehensive auto insurance policy would pay out if it is lost or stolen.

Key Takeaways

  • Gap insurance—also known as guaranteed auto protection—reimburses a car owner when the payment for a total loss is less than the outstanding loan or lease balance.
  • Gap insurance makes the most sense for people who put no money down and choose a long payoff period. For a couple of years, they may owe more on the car than its current value.
  • It also makes sense for those who lease rather than purchase a vehicle.
  • You may be able to skip gap insurance if you made a down payment of at least 20% on the car when you bought it, or if you're paying off the car loan in less than five years.
  • You don't need gap insurance for the life of the car, just until your loan balance doesn't exceed the car's value.

How Gap Insurance Works

It’s fairly easy for a driver to owe the lender or leasing company more than the car is worth in its early years. A small down payment and a long loan or lease period are enough to do it, at least until your monthly payments add up to sufficient equity in the vehicle.

And, remember, that equity must equal the current value of the car. That value, not the price you paid, is what your regular insurance will pay if the car is wrecked.

The problem is that cars depreciate quickly during their first couple of years on the road. In fact, the average automobile loses nearly a third of its value after just two years of driving.

If your vehicle is wrecked, your policy won't pay the cost of replacing the car with a brand-new vehicle. You’ll get a check for what a car comparable to yours would sell for on a used-car lot. Insurers call this the vehicle’s actual cash value

Gap insurance doesn't cover that particular gap. The payouts are based on actual cash value, not replacement value.

Example of Gap Insurance

Say you purchased a new car with a sticker price of $28,000. You paid 10% down, bringing your loan cost down to $25,200. You got a five-year auto loan. For the sake of simplicity, let's say you scored one of those zero-percent new-car financing deals, so your monthly payment is $420. After 12 months, you've paid $5,040. You still owe $20,160.

One year later, the car is wrecked and the insurance company writes it off as a total loss. According to your auto insurance policy, you are owed the full current value of that vehicle. Like the average car, your car is now worth 20% less than you paid for it a year ago. That's $22,400.

Congratulations. Your collision coverage will reimburse you enough to cover the outstanding balance on your car loan and leave you $2,240 to put down on a replacement vehicle.

But wait. What if your car was one of the models that don't hold their value as well? Some cars depreciate by 30% in the first year after their purchase. In that case, your insurance check will be $19,600.

You owe your lender $560. And you still need a new car.

If you don't have gap coverage
 Total Loan Amount Owed  $20,160
 Collision Insurance Payout $19,600 
Shortfall  $-560
 (Gap Payout)  (0)
 Your Out-of-Pocket Cost  $560
If you have gap coverage
 Total Loan Amount Owed  $20,160
 Collision Insurance Payout  $19,600
 Shortfall  $-560
 Gap Payout   $560
 Your Out-of-Pocket Cost   $0

Do You Need Gap Insurance?

You may have heard the term "upside-down" in reference to a home mortgage debt. The concept is the same whether the item financed is a house or a car: The thing financed is currently worth less than the balance of the loan that was taken out to acquire it.

This isn't as dire as it sounds. If you put only a little money down on a purchase and pay the rest in small monthly installments spread over five years or more, you don't immediately own much of that house or car free and clear. As you pay down the principal, your ownership share expands and your debt shrinks.

Gap insurance at least covers the shortfall so you're not on the hook if the car is wrecked.

Gap Insurance May Make Sense If...

  • You leased rather than purchased the vehicle, and paid little or no cash down for it.
  • You bought the vehicle with little or no money down and a long loan payoff period.

In either case, you put little of your own cash on the table to get this deal. That's great. You got a good deal on the car. But it probably means you owe more money on that vehicle than you will get from your insurance company if it is wrecked or stolen in the next couple of years. You could use gap insurance.

If you've purchased gap insurance, check your loan balance from time to time and cancel the insurance once you owe less than the book value of your vehicle.

You May Be Able to Skip Gap Insurance If...

If you're still paying off your car, you almost certainly have collision coverage. You'd be playing with fire without it, and, in any case, you're probably required to have collision coverage by the terms of your loan or lease agreement.

  • You made a down payment of at least 20% on the car when you bought it, so there’s little chance you will be upside-down on your loan, even in the first year or so that you own it.
  • You're paying off the car loan in less than five years.
  • The vehicle is a make and model that historically holds its value better than average.

It's worth checking the National Automobile Dealers Association (NADA) guide or Kelley Blue Book periodically to get an idea of how much your car is worth. Compare it to your loan balance. If your loan balance is less than your car's value, you no longer have a gap to worry about.

Pros and Cons of Gap Insurance

Buying a new car is an expensive proposition these days. The average new car loan is in excess of $32,000. The average loan term is now 69 months. 

You wouldn't dream of skipping collision insurance on that car, even if your lender allowed you to do it.

You should consider gap insurance to supplement your collision insurance for the period of time that you owe more for that car than its actual cash value. That is what your collision insurance policy will pay out if the car is wrecked.

This is most commonly the case in the first few years of ownership if you put down less than 20% on the car and stretched the loan repayment term to five years or more.

A quick look at a Kelley Blue Book will tell you whether you need gap insurance. Is your car currently worth less than the balance on the loan? If so, you need gap insurance.

How Much Does Gap Insurance Cost?

You can add gap insurance to your regular comprehensive auto insurance policy for as little as $20 a year, according to the Insurance Industry Institute.

That said, your cost will vary according to the usual laws of insurance. That is, your state, age, driving record, and the actual model of the vehicle all play a part in pricing.

A major insurer will typically price it at 5% to 6% of the collision and comprehensive premiums on your auto insurance policy. For example, if you pay $1,000 a year combined for those two coverages, you’ll only have to kick in $50 to $60 extra a year to protect your loan with gap insurance.

Going to an insurer for gap coverage is usually cheaper than the two other options, going through the dealer or a lender, according to Bank Rate Monitor.

The Dealer Option

There’s a good chance the car dealer will try to sell you gap coverage before you drive off the lot. In fact, some are required by state law to offer it.

But dealers typically charge substantially more than the major insurance companies. On average, a dealership will charge you a flat rate of $500 to $700 for a gap policy.

So, it pays to shop around a bit, starting with your current auto insurer. Many insurers will allow you to add gap insurance to your existing auto insurance policy.

Another advantage of going with a big-name carrier is that it's easy to drop the gap coverage once it no longer makes financial sense.

Gap Insurance FAQs

Here are some brief answers to the most commonly-asked questions about gap insurance.

Is Gap Insurance Worth the Money?

If there is any time during which you owe more on your car than it is currently worth, gap insurance is definitely worth the money.

If you put down less than 20% on a car, you're wise to get gap insurance at least for the first couple of years you own it. By then, you should owe less on the car than it is worth. If the car is wrecked, you won't have to pay out-of-pocket to make up the shortfall between the insured value of the car and the amount you owe a lender.

Gap insurance is particularly worth it if you take advantage of a dealer's periodic car-buying incentive. If you're getting a deal for a low down payment and three months "free," you are surely going to be upside-down on that loan for many months to come.

Do You Need Gap Insurance If You Have Full Coverage?

Comprehensive auto insurance is full coverage. It includes collision insurance but also covers every unexpected calamity that can destroy a car, from vandalism to a flood. But it pays the actual cash value of the car, not the price you paid for it or the amount you may still owe on the loan.

Gap insurance covers the difference.

So, you need gap insurance if there is indeed a gap between what you owe and what the car is worth on a used car lot. That is most likely to occur in the first couple of years of ownership, while your new car is depreciating faster than your loan balance is shrinking.

You can cancel the gap insurance once your loan balance is low enough to be covered in full by a collision insurance payment.

What Does Gap Insurance Do?

Think of it as a supplemental insurance policy for your car loan. If your car is wrecked, and your comprehensive auto insurance policy pays less than you owe the lender, the gap policy will make up the difference.

How Do I Get Gap Insurance?

The easiest way, and probably the cheapest way, is to ask your auto insurance company if they can add it to your existing policy.

You can compare prices online to make sure you're getting the best deal.

The car dealership will probably offer you a gap policy but the price will almost certainly be higher than a major insurer will offer.

In any case, check to make sure you don't already have gap insurance on your vehicle. Auto lease deals often build gap coverage into their pricing.

Can You Get Gap Insurance After You Buy a Car?

Yes. Your best bet is to call your auto insurance company and ask whether you can add it to your existing policy.

The Bottom Line

Did you know that there are actually six types of auto insurance and another five optional insurance products for drivers? And, as if that weren't complicated enough, the requirements for coverage and the cost of the products differ by state.

Gap insurance is one of those optional "other" products unless it's required by the terms of your lease or loan agreement.

Nevertheless, it's a product that could give you considerable peace of mind if you recently shelled out for a new car.

Suppose you bought a $30,000 car and, two years later, it's stolen and never recovered. Due to depreciation, the car is now worth only $21,000 on the market. You still owe the lender $24,000.

If you have gap coverage, the insurance carrier will kick in $3,000 to cover the difference. If you don't, you owe the lender $3,000 out of pocket.

Gap insurance is sensible for those with significant negative equity in a car. That includes drivers who put little money down or have a protracted loan payoff period. If you're interested in cutting your car insurance costs, not paying for gap insurance once you don't really need it is one way to save some money.