Gap Insurance: What It Is, And How it Works

Written by Kim PinnelliUpdated: 20th May 2022
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Owing more than your car is worth is a scary situation. If you total your car, what happens? Insurance pays you up to the amount you’re covered, leaving you to pay only a fraction of the cost.

If you don’t make up the difference, you could ruin your credit and make it impossible to get another car loanto replace the lost car.

Gap insurance can help fill the ‘gap,’ so to speak, but it’s not for everyone. Here’s what you should know about gap insurance and how it works.

What Is Gap Insurance?

Gap insurance is coverage for drivers who financed or leased their car to cover the difference between the car’s value and the amount owed to the bank.

Since cars depreciate fast (hello, 20% depreciation when you drive off the lot), it’s easy to be underwater faster than you realize. If the thought of owing the difference between the car’s value and what you owe scares you, gap insurance can fill the void, covering you should the worst happen.

Do I Need Gap Insurance?

Many people don’t need gap insurance. Lenders do not require it, they require only collision and comprehensive insurance, but you might want to consider gap insurance if any of the following apply to you.

  • You bought a car that depreciates fast. If you know the make and model you purchased loses value fast, you could quickly be upside down on your loan, and you may want to protect yourself.
  • You didn’t make a large down payment. If you didn’t put much down on the car and you took a long loan term, you could be upside down quickly. The more money you put down, the less likely you need gap insurance.
  • You drive a lot. If you put a lot of miles on your car, it will depreciate faster, making you owe more than it’s worth quickly.

If you lease the car, gap insurance might be required. Check with the leasing company to find out for sure and work that into your budget when you determine if leasing is a good idea.

How Does Gap Insurance Work?

Gap insurance is like secondary insurance. It only comes into play if your primary insurance coverage doesn’t cover the full amount of a total loss (collision or theft).

Here’s what happens. Regular car insurance only pays the cash value of the car. If your car is worth $5,000, but you owe $8,000, you’d be on the hook for the additional $3,000. This happens when you borrow most of the car’s purchase price, or the car depreciates fast.

Gap insurance would kick in after your regular car insurance paid the $5,000, making up the $3,000. Of course, this comes at a cost as you must pay the premiums for gap insurance.

If the insurance company doesn’t total your car, gap insurance isn’t effective, which is why many people wonder if it’s worth it.

Is Gap Insurance Worth It?

Gap insurance is only worth it if you are upside down on your car and the premiums are affordable. Do the math and see how much you’d pay in total premiums while you carry the policy to make sure it is less than what the gap insurance would have to cover if you need it.

If you will pay more in premiums than the value of the gap insurance, though, it’s not worth it. As you pay your loan balance down, you may no longer have much of a gap, making gap insurance irrelevant.

Like we said earlier, leasing companies often require it, so they don’t end up with a loss if you total the car. In that case, it’s worth it but adds to leasing a car’s expense.

What Isn’t Covered by Gap Insurance?

Gap insurance only covers the difference in the car’s cash value and how much you owe IF you total the car or it’s stolen. It won’t cover you if you’re in an accident and the car is repairable. It also doesn’t cover normal wear and tear, engine failure, or the cost of a rental car while your car is repaired.

How to Calculate Gap Insurance

It’s easy to calculate gap insurance. You need calculate the difference between the car’s current value and your outstanding loan balance. Your gap coverage would be the difference and would only be useful if you have a total loss.

How Long Does It Take for Gap Insurance to Pay?

Car insurance companies can take a few days or as long as a month to decide to total out a car. Once they decide, you can file a claim with your gap insurance which might payout in a few days to a month. Some states have requirements regarding how fast insurance companies must pay, though.

When Does Gap Insurance Not Pay?

Gap insurance won’t pay unless the car insurance company totals your car. If they don’t call it a total loss, gap insurance doesn’t cover anything.

Bottom Line: Understanding Gap Insurance

Give careful thought before investing in gap insurance. It’s not required by lenders or the law. It’s an optional policy for peace of mind should you total your car.

As you pay your loan balance down, pay close attention to whether you still have a ‘gap’ and need the insurance. If you don’t owe more than the car is worth, don’t pay the premiums unnecessarily. Owning a car is expensive enough, don’t add to the expense if you don’t have to.

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Kim Pinnelli
Kim Pinnelli

Kim Pinnelli is a Senior Writer, Editor, & Product Analyst with a Bachelor’s Degree in Finance from the University of Illinois at Chicago. She has been a professional financial writer for over 15 years, and has appeared in a myriad of industry leading financial media outlets. Leveraging her personal experience, Kim is committed to helping people take charge of their personal finances and make simple financial decisions.