When you purchase a new car, you may read over your loan terms and wonder, “What is gap insurance?”
Gap insurance is an optional coverage you can add to your personal auto policy that covers the difference if your vehicle is totaled or stolen and the insurance payout isn’t enough to cover the outstanding car loan balance.
Often dealerships will include gap insurance, also known as loan or lease gap coverage, as part of the loan package. Read on to learn how gap insurance works and whether it’s worth it.
How does gap insurance work?
You’ve probably heard that as soon as you drive a new car off the lot, it’s worth less than you paid for it. Unfortunately, this is true: While you’re still breathing in the new car smell, your car is losing value.
New cars depreciate about 20% in the first year, but the amount you owe on your loan doesn’t, which is a problem if your vehicle is stolen or totaled early. Most insurance companies will consider a car totaled if the cost to repair it is greater than the car’s actual cash value (ACV), although it varies by state law and how your insurance operates.
Collision and comprehensive coverage will only cover the car’s ACV minus the deductible. This means the insurance payout may not be enough to settle the outstanding loan balance. That’s where gap insurance comes in.
Say you buy a car for $25,000. At the end of the first year, its ACV might be $17,500, but you might still owe $20,000 on your loan. If the vehicle is totaled or stolen at that point, your insurance company will pay $17,500 minus the deductible and you’d be responsible for the loan balance of $2,500. In this instance, gap insurance would take care of the outstanding $2,500 to pay the bank loan in its entirety.
What does gap insurance cover?
Gap insurance covers the difference between the car’s ACV and what you still owe on the loan any time the insurance company declares your car a total loss. A gap insurance policy may have a limit (usually a percentage of the car’s value) so it won’t cover the entire difference, but every little bit helps when you’re paying for a car you can no longer drive.
Readers should note that gap insurance never covers the car itself or any damages or injury it causes. Your liability, collision and comprehensive policies cover that. Gap insurance won’t cover the costs of purchasing a new car, either. The full reimbursement amount will go directly to your auto lender to settle the debt.
Some gap insurance policies have specific requirements, such as you being the original owner or the vehicle falling within a particular age range. You may also be required to have both comprehensive and collision coverage.
The role of vehicle depreciation
The decision to get gap insurance mainly depends on how fast your vehicle will depreciate. According to one report, the average car depreciation rate over five years is 33.3%, although it can vary greatly by model and economic conditions.
During the pandemic and subsequent supply chain issues, vehicle depreciation slowed because used cars were in high demand. Gas prices can also impact a car’s depreciation rate. When fuel prices are high, fuel-efficient vehicles experience slower depreciation rates than gas guzzlers.
Luxury brands and large sport utility vehicles (SUVs) have the highest depreciation rates. People who buy used cars tend to care less about high-end features than new car buyers, making luxury vehicles worth less on the resale market.
Recent high gas prices have also caused SUVs to lose resale value as people try to cut corners wherever possible. The top three vehicles with the highest depreciated values are:
- BMW 7 Series: depreciation rate of 56.9%
- Maserati Ghibli: depreciation rate of 56.3%
- Jaguar XF: depreciation rate of 54%
Look for popular, best-selling cars or cars that are fuel efficient if you’re looking for vehicles with the lowest depreciation rate. The Jeep Wrangler has a depreciation value of 7.3% over five years, and the Honda Civic has a 16.3% depreciation rate. Both are well below the national average.
During the pandemic, a few sports cars also saw lower depreciation rates. Not only did they become harder to find due to global supply chain issues, but they also became a source of escapism during the pandemic. The Porsche 911, Ford Mustang and Chevrolet Camaro all have five-year depreciation rates below the national average.
Because they are fuel efficient, hybrids have a five-year depreciation average of 28.8%. Electric cars, however, have a higher-than-average five-year depreciation rate of 44.2%. The technology is still relatively new, and each generation offers improvements that make older models less appealing. The government also provides significant tax incentives and rebates to purchase electric vehicles, but only newer models, which may also account for their higher depreciation rate.
How much is gap insurance?
The cost of gap insurance varies by provider and a few other factors, such as:
- The ACV of the car compared to the loan amount
- Your age
- Your state
- Your claims history
The good news about gap insurance is that you can drop it as soon as your loan is worth less than your car’s ACV. Be aware that you’ll need to call your agent to cancel the gap insurance because it won’t automatically drop off your policy. When you call an insurance provider to ask how much car insurance is, you can also ask about their gap insurance rates.
When do you need gap insurance?
Gap insurance, unlike liability insurance, isn’t legally required when you purchase a car. You have the right to decline it even if the dealership includes it in your loan paperwork.
The one exception is if you lease your car. Lessors require gap insurance to ensure they’ll get compensated if something happens to the vehicle during the lease terms, even if the leaser can’t afford to pay for it.
That said, having gap insurance — even if it isn’t legally required — makes a lot of sense when the gap between your car’s ACV and what you still owe is significant.
Consider getting gap insurance if you fall into any of the following situations:
- You put down less than 20% on the car. You’re more likely to be stuck with an upside-down loan if your car is totaled or stolen. The average car depreciates 20% in the first year, and you won’t pay off 20% of the loan in that time frame.
- You financed for a period longer than 60 months. Extending your finance period helps lower your monthly payments, but it also means it will take you longer to pay down the amount you borrowed. As a result, your car is more likely to depreciate faster than you pay off the loan, increasing the likelihood you’ll owe more than the car’s ACV if it’s stolen or totaled early.
- You purchased a vehicle with a quick depreciation rate. Some vehicles, like luxury cars, large SUVs and electric vehicles, depreciate faster than others. When researching what new car you want to purchase, look into its depreciation rate and safety features to determine if gap insurance will be worthwhile.
- You rolled over an upside-down car loan into your new loan. Say you traded in a car worth $1,000 but still owed $2,500 on the original loan. The dealership will simplify the process by rolling that $1,500 into the new car loan. You’ll only be paying for one car loan instead of two, which means you'll owe more on the loan than your current car is worth. Gap coverage would cover that difference, even if part of the loan was from another car.
- You put a lot of miles on your vehicle. After the first year, the biggest impact on a car’s depreciation rate is the number of miles on it. If you drive a lot, you’ll likely need gap insurance to pay off the loan if something happens to your car.
If you aren’t sure if you need gap insurance, look up your car’s current value using a resource like Kelley Blue Book and compare it to your remaining loan balance. If the difference is larger than you can afford to pay, call your insurance agent and ask whether you qualify for gap insurance.
The benefits of buying gap insurance
Waking up one day and discovering your new car has been stolen is terrible, but finding out you still have to pay for it could make a terrible situation even worse. Gap insurance protects you from situations like this where you have to pay money for something you can’t even use.
Another benefit to gap insurance is that there’s no deductible involved. Your collision and liability policy will cover the ACV minus the deductible and gap insurance will cover what remains on your loan (up to the policy’s payout limit, if applicable) whether your deductible on collision was $500 or $1,500.
Where to buy gap insurance
You can get gap insurance from your dealership or the lender (bank or credit union) financing your car purchase. However, you’ll probably pay more for it over time because they will roll it into the total of your loan.
For example, if your gap insurance is estimated to be $600 a year for the five-year life of the loan, the dealership or lender will add $3,000 to the loan and have you pay it plus interest throughout the life of the loan.
Your insurance provider may offer a better deal. They’ll add gap insurance to your existing auto policy and you’ll pay monthly or annual premiums for the coverage.
Alternatives to gap insurance
If you aren’t interested in gap insurance, there are other ways to protect yourself, such as:
- Putting down a higher down payment. If you can put down more than 20% on your car loan, the odds are good you’ll never be upside-down. The biggest depreciation period is when the car is new and a high down payment can offset that loss of value.
- Getting a loan with a shorter repayment length. You’re more likely to keep up with your car’s depreciation if you repay the loan over a shorter time frame, with higher monthly payments.
- Purchasing new car replacement coverage. Gap insurance just pays off the balance of the loan. It does not leave you with any money for a down payment. This hinders the purchase of a new car, mainly because car owners tend to trade in their current vehicle to cover the down payment for a new one. New car replacement coverage will reimburse you enough to buy your exact car, although age and mileage requirements may apply.
- Purchasing better car replacement coverage. A better car replacement policy reimburses you for a car that is one model newer or with a certain number of fewer miles. For example, if your totaled car was a 2015 Nissan Rogue, your insurance provider would reimburse you enough to purchase a 2016 Rogue.
- Buying a car with a lower depreciation rate. You can skip gap insurance coverage if you know your car’s depreciation value will keep pace with your loan payments.
Summary of what is gap insurance
If you can afford it, gap insurance is a powerful tool to protect you in the event your newer car is totaled or stolen. It covers the difference between what your car is worth and the amount you owe on your loan. Purchasing gap insurance isn’t required by law when financing a car but dealerships may require it if you are leasing your vehicle.
Your dealership will probably offer you gap insurance, or you can get it through any of the best auto insurance companies, a bank or a credit union. If you’re interested in gap insurance but can’t afford it on top of your current policy, check out our list of the best cheap car insurance providers and ask them for a quote today.