Gap Insurance: How It Works & What It Covers

If you’ve leased or financed a car in the last 25 years, chances are you’ve carried GAP insurance. If you’re thinking about leasing or taking out an auto loan, it’s almost certain that the dealership will try to sell you GAP insurance.

You may well need the coverage, but you don’t necessarily have to buy it from the car dealer. Before you select an auto insurance policy and add GAP insurance, here’s what you need to know.

Standard auto insurance policies won’t pay out what you paid for the car. Instead, they cover the actual cash value, or ACV, of the car. Your insurance settlement will be the actual cash value at that time, minus your car insurance deductible. For example, if they determine your car is worth $4,000 and you have a $500 deductible, your payout will be $3,500.

The discrepancy between the initial cost of a car and the depreciating worth is what often gives car owners a nasty surprise: They owe more than what the car is worth. If their car is totaled or stolen, the insurance company pays out substantially less than what they owe. You’re on the hook for the difference — which could amount to thousands of dollars.

And you still have to come up with a down payment and qualify for financing for a replacement vehicle so that you can go to work, get your kids to events and do the basic tasks of daily living.

That’s where GAP insurance comes in. GAP is an acronym for Guaranteed Asset Protection. It covers the difference between the value of the car and what you owe on it. If your car is totaled or stolen and you’re “upside-down” on the loan, you’ll be glad to have GAP insurance.

The benefit isn’t paid to you directly; it’s paid to the finance company to pay off your loan or lease.

Specifics vary by carrier, but in general, GAP insurance works like this:

You buy a brand-new car for $25,000. You get in a wreck and the car is totaled. At the time of the accident, you still have a loan balance of $20,000. Your collision coverage would pay your lender up to the totaled car's depreciated value. If the car has an actual cash value, after depreciation, of $18,000 at the time of the wreck, you would have to pay $2,000 in cash to clear your loan. If you have GAP insurance, your insurer would help pay the $2,000.

If you have a $1,000 deductible, and your GAP insurance policy includes deductible coverage, they would pay an additional $1,000.

Here are other details about GAP insurance that you may find useful:

• In the event of a total loss, including theft, GAP insurance will pay the difference between your vehicle’s actual cash value and the balance you owe. In some cases, they will also pay your deductible, so you won’t have to pay out of pocket in the event your car is totaled.
• Your payoff balance is calculated as of the time of the loss, using the loan’s original payment schedule.
• The coverage is capped: $25,000 is common, but check your policy’s fine print for specifics.
• GAP insurance provides no benefit if your car is not a total loss, or if the car is worth at least what you owe on the loan.
• Some vehicles, such as high-ticket luxury or sports cars, are not eligible for coverage at some carriers.
• Some carriers won’t underwrite cars with certain types of loans, including loans with balloon payments, loans longer than 72 months, loans that are not fully amortized or very large loans.
• You don’t need collision insurance or comprehensive coverage to have GAP insurance.
• If you pay a lump sum and cancel the policy, you may receive a refund of the unused premium.
• If you don’t have GAP insurance now and you decide you want it, you can buy it at any time from your insurance carrier or stand-alone GAP insurance provider — provided you haven’t already suffered a loss.

Do you need it? Well, that depends. The average new car will lose 60% of its value within three years of normal driving. Many cars lose around 30% after the first year, according to Edmunds.com. After three to five years, you can expect a car to be worth about 40% of what it cost new. If you’re a ride-share driver, or otherwise put a lot of miles on your vehicle, it’s going to lose a lot more.

Furthermore, luxury sedans tend to lose value faster than other models, according to the 2019 Vehicle Depreciation Report from Black Book and Fitch Ratings.

GAP insurance is becoming more important to consumers as car loan terms get longer and longer. According to data from Experian, the average term on a new-car loan is now a record 68 months. Further, 84-month terms are becoming increasingly common. A growing number of people are even financing cars over 96 months.

In most cases, the longer the term, the lower the monthly loan payment — which means you’re going to be upside down for a longer period of time and drive more miles while you’re upside down.

That’s why both the frequency and amount of GAP insurance claims are on the rise.

If you have a small down payment and a long loan, say, between a 36- and 96-month term, chances are you’re going to be underwater for a long while. You’ll owe more on the car than it’s worth. And unless you can easily write a check for the difference, you may need GAP insurance. In fact, most finance companies will require it if they project that you’ll owe more than the car is worth in the first couple of years.

If the cost of having your car totaled in the first few years you own or lease it will be a hardship for you, you should probably consider buying GAP insurance.

The average GAP insurance claim these days is between $3,200 and $4,500, says Tony Wanderon, president and CEO of National Auto Care in Ponte Vedra Beach, Florida. In recent years, GAP insurance providers have been taking underwriting losses. Claims are coming in higher and more often than underwriters predicted when they set prices. Those statistics indicate that GAP insurance is generally a good buy for consumers — if your dealer or finance company doesn’t mark up the policy too much and hide it in your loan.

According to the Insurance Information Institute (III), GAP insurance is worth considering under the following circumstances:

• You’re buying a new or nearly new vehicle.
• You’re financing it for 60 months or longer.
• You made a small down payment — or no down payment at all.
• You rolled over negative equity from an old car to a new one.
• You’re buying a car that depreciates faster than most.
• You’re planning to drive a lot of miles early in the lease.
• Your interest rate is high, which means you build less equity in the early years of the loan, and you stay upside down longer.

You may want to skip the GAP coverage if:

• You made a big down payment.
• Your car loan term is 36 months or less.
• You’re paying the loan down ahead of schedule.
• You can easily afford the risk and would rather invest the money.

Car leases usually require some sort of GAP coverage. It’s typically written into the lease agreement. This is called loan/lease coverage, and it’s like GAP insurance. However, unlike most GAP insurance policies, loan/lease insurance policies usually just pay a percentage of the actual cash value of the car.

As with all financial products, you should shop around for GAP insurance. You have three options:

• Buy it from the car dealer or lender. This is typically a lump-sum premium. The dealer pays it for you, and then rolls the premium price into your loan, at your normal rate of interest.
• Buy it from your own auto insurance company. This is typically a monthly or six-month premium, and you won’t be charged interest on it.
• Buy it from a specialty GAP insurance carrier. This is typically for a lump-sum premium.

Dealer-sold GAP insurance is almost always the most expensive option, by far. Dealer-sold premiums are often two to four times those available from third-party and stand-alone insurance companies, according to Steve Lehto, a Michigan attorney specializing in automotive and lemon laws. However, if you can handle the premium, dealer-sold GAP insurance may have some advantages:

• Dealer-sold GAP coverage is more likely to be available for negative equity rolled over from a prior loan — up to 150% of manufacturer suggested retail price (MSRP). Most insurance carriers won’t offer this as an option.
• Dealers may have higher coverage limits. If you’re buying an expensive vehicle and you want GAP insurance, you may have to buy it through the car dealer.
• Dealer-sold policies may also cover your deductible, up to $1,000. But if you shop around, you may find insurance carriers have this option, as well. Gap Direct, for example, has this feature.
• If your insurance carrier also carries your GAP insurance, they may be less likely to total your car — even though you’d be better off if they did.

Buying GAP insurance from your own insurance carrier has the advantage of a lower premium. If you add GAP coverage to your collision and comprehensive auto insurance policy, your premiums may be as low as $20 per year, according to the III.

Plus, since you’re paying monthly, you can cancel the coverage as soon as you’re no longer upside down on your loan. You may not have this option with lump-sum policies, especially when the premium has been rolled into your loan.

Most consumer advocates recommend you refuse the dealer GAP coverage and compare quotes from your own insurance carrier or from a stand-alone GAP insurance vendor.

“Your insurance company will sell you GAP insurance for far less than what your dealer will do,” says Ari Janessian, CEO and founder of Boston Automotive Consulting. “I encourage you to negotiate the heck out of it,” he says.

One technique Janessian suggests is to get a GAP offer from your insurance company and see if the dealer will match it. This works better if you have a great interest rate.