How Does Gap Insurance Work?

If your automobile is totaled or stolen and you owe more than the car’s depreciated worth, gap insurance, an optional form of auto insurance, can help. “Loan/lease gap coverage” is another name for gap insurance. You can only get this kind of coverage if you were the first person to take out a loan or lease on a new car. Gap insurance bridges the difference between your car’s depreciated value and the balance you still owe on it.

Important takeaways: 

  • Gap insurance is only worthwhile if you are leasing a car or have loan debt that is greater than the value of the vehicle.
  • If you don’t have a car loan or lease, gap insurance is not necessary.
  • Gap insurance won’t be necessary forever. Once your loan balance is less than the value of your car, stop paying gap insurance.

How does gap insurance work?

The most your insurer will pay out on a claim for a totaled vehicle in an incident covered by collision or comprehensive insurance is the car’s pre-accident worth.

The difference between what you owe and the value of your totaled or stolen vehicle is covered by gap insurance, often known as loan/lease coverage.

A typical gap insurance claim proceeds as follows:

  • You file a claim on either the collision or comprehensive insurance section of your policy if your automobile is stolen or totaled in an accident that is covered by your auto insurance (whichever coverage applies).
  • Your auto insurance provider reimburses you for your vehicle’s ACV, less your deductible. For instance, your insurance payment would be $16,500 if your automobile is worth $17,000 and you have a $500 deductible.
  • Gap insurance can cover the difference if you owe more on your loan or lease than the value of your car is covered by insurance. Your gap insurance will pay $3,000 in this scenario: You owe $20,000 and the ACV is $17,000.
  • You will be liable for paying off the loan yourself if you don’t have gap insurance and the remaining debt on your loan or lease is higher than the worth of your car. You might need to get gap insurance, depending on your lender or leasing company. This is because, in the event that the car is totaled or stolen, it helps shield them from buyers who walk away from a loan or lease.

You might be covered by some gap insurers for the entire loan debt, even if negative equity has been rolled into your new car loan. If you trade in a car, for instance, and owe more than it is worth, the difference is rolled into your new loan. If you rolled negative equity into your new car loan, be careful to choose a policy that does as not all gap insurance products will.

What is not covered by gap insurance?

The following are some typical costs that gap insurance doesn’t cover:

  • Your deductible for auto insurance
  • Late fees and unpaid balances on your auto loan or lease
  • Security remittances
  • Additional warranties
  • amounts from earlier loans or leases that have carried over
  • penalties for exceeding mileage or usage limits
  • Fees for the loan’s associated credit insurance
  • a deposit on a new vehicle

Here’s an illustration of how gap insurance might operate: Say you spent $25,000 on a brand-new vehicle. When the automobile is totaled in a covered collision, you still owe $20,000 on your auto loan. If your automobile was totaled and its depreciated value was $19,000, your collision insurance would compensate your lender up to that amount. Without gap insurance, you would be required to pay $1,000 out of pocket to pay off your auto loan on the totaled vehicle. Your insurer would contribute to the $1,000 if you have gap insurance.

Remember that in the aforementioned instance, the car insurance reimbursement goes entirely to your car lender to settle the balance on a vehicle that can no longer be driven. Consider buying new car replacement coverage if you believe you would require assistance in purchasing a new vehicle if yours were totaled. Some insurance companies offer new car replacement coverage and loan/lease gap coverage as a single add-on to an auto insurance policy for a brand-new vehicle.

Why do I require gap coverage?

Many lenders mandate collision and comprehensive coverage on your auto insurance policy up until your automobile is paid off if you’re leasing or financing a new vehicle.

The purpose of gap insurance is to supplement collision or comprehensive insurance. Your collision policy or comprehensive coverage will assist pay for your totaled or stolen vehicle up to its depreciated worth if you have a claim that is covered. The Insurance Information Institute (III) claims that as soon as you drive a brand-new car off the lot, its value starts to fall. Additionally, the value of the majority of vehicles decreases by roughly 20% in the first year of ownership.

But what if your loan or lease balance is still higher than the car’s depreciated value? Gap insurance could be useful in this situation.

When gap insurance may be necessary

When your automobile is stolen or damaged, gap insurance coverage can be applicable if you’re underwater on your loan—that is, if you owe more than the car is worth. “Totaled” signifies that the vehicle’s repair expenses are higher than its market value. The decision of your insurance and state regulations will determine whether a vehicle is classified a total loss.

Does gap insurance pay off?

It’s crucial to keep in mind that this type of coverage might only be accessible if you’re leasing or financing a new vehicle if you’re thinking about purchasing gap insurance. Then consider your auto loan balance in relation to the market worth of your vehicle. (You can find out the estimated value of your car by visiting a website like Kelley Blue Book.) Does your debt exceed the value of your car? If your automobile is totaled, could you afford to pay the difference yourself?

The III suggests that you take into account gap insurance in the following circumstances:

  • If you bought your car with less than a 20% down payment
  • if the length of your auto loan is at least 60 months
  • if you are renting a car. The III points out that many lease agreements for new car leases provide gap coverage. To determine if you have coverage, check yours.
  • Have inquiries regarding gap insurance? Speak with your insurance company; they can assist you understand your alternatives.


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