What Gap Insurance Does and When You Might Need It

Gap insurance covers the difference between what you owe on a car loan and what the car is worth if it's totaled

When you finance or lease a car, you owe the lender money. If the car is in an accident and declared a total loss, your regular car insurance pays you what the car is worth at that moment — not what you paid for it. If that payout is less than what you still owe on the loan, you're responsible for the difference. Gap insurance (may provide Asset Protection) covers that gap.

Example: You buy a car for $30,000 and finance $28,000. Six months later, it's totaled. Your car is now worth $24,000 according to the insurance company's valuation. Your regular insurance pays $24,000. You still owe $27,000 on the loan. Gap insurance would pay the $3,000 difference, so you're not stuck paying for a car you no longer have.

Gap insurance only pays if the car is totaled — not for regular collision damage, theft, or other claims. It also only covers the gap itself, not repairs or other costs.

Key Takeaways

• Gap insurance pays the difference between your car's actual cash value and what you still owe if the car is totaled.
• You're most likely to need it in the first few years of a loan, when you owe more than the car is worth.
• Many lease agreements require gap insurance, and some lenders require it for loans with a down payment under 20 percent.
• You can buy gap insurance from your car insurance company, the dealership, or the lender, and the cost and coverage vary by source.

When you owe more than the car is worth

New cars lose value quickly. In the first year, a new car typically loses 15 to 20 percent of its purchase price. If you put down a small down payment or finance the full amount, you can easily owe more than the car is worth within months.

This situation — owing more than the car is worth — is called being "underwater" or "upside down" on the loan. The longer the loan term, the more likely you are to be underwater early on. A 72-month loan means you're paying for the car over six years, while the car depreciates much faster.

Used cars depreciate more slowly than new cars, so if you buy a used car with a larger down payment, you may never be underwater. Gap insurance is most useful for new car purchases with small down payments and longer loan terms.

Leases almost always require gap insurance

If you lease a car, your lease agreement typically requires you to carry gap insurance. The leasing company owns the car and wants protection if it's totaled while you're driving it. Many leasing companies include gap insurance in the lease cost automatically, so check your lease paperwork to see if you already have it.

If gap insurance is not included in your lease, you can buy it from your car insurance company. The cost is usually $15 to $25 per year for a lease, which is lower than for a financed purchase because the leasing company's risk is different.

Where to buy gap insurance and what it costs

You have three main sources for gap insurance: your car insurance company, the dealership, or the lender. Each has different costs and coverage terms.

Through your car insurance company: This is usually the cheapest option. You add gap coverage to your existing policy, and it costs $15 to $30 per year depending on your state and the car's value. You can add it at any time, even months after you buy the car. Coverage is straightforward and works the same way as other insurance claims.

Through the dealership: Dealerships often offer gap insurance as an add-on when you buy the car. The cost is rolled into your loan, so you pay interest on it over the life of the loan. A $500 gap insurance product might cost $650 or more by the time you finish paying the loan. Dealership gap insurance is convenient but expensive, and you can't cancel it without refinancing.

Through the lender: Some banks and credit unions offer gap insurance directly. The cost and terms vary. Like dealership coverage, it's often rolled into the loan amount, which means you pay interest on it. Ask your lender what they offer before you go to the dealership.

What gap insurance does not cover

Gap insurance only covers the difference between what you owe and what the car is worth if the car is totaled. It does not cover collision damage, theft, medical bills, or liability. You still need regular comprehensive and collision coverage for those things.

Gap insurance also does not cover regular wear and tear, maintenance, or repairs. If your car is damaged but not totaled, your collision insurance handles it — gap insurance does not pay anything.

If you owe more than the car is worth because you rolled negative equity from a previous loan into this one, gap insurance covers only the gap on the current loan, not the rolled-over amount. Some gap policies have limits on how much they'll pay, so read the terms carefully.

How to decide if you need gap insurance

Ask yourself these questions: Did I put down less than 20 percent? Is my loan longer than 60 months? Did I buy a new car? If you answered yes to any of these, you're likely underwater early in the loan, and gap insurance makes sense.

If you're buying a used car with a substantial down payment and a shorter loan term, you probably don't need gap insurance. If your lease requires it, you need it — but check whether it's already included.

If you already have gap insurance through the dealership and want to switch to a cheaper policy through your insurance company, you can usually cancel the dealership coverage by refinancing the loan or paying it off early. Talk to your lender about the process.

Frequently Asked Questions

Does gap insurance cover me if I'm in an accident but the car isn't totaled?

No. Gap insurance only pays if the car is declared a total loss by the insurance company. For accident damage that doesn't total the car, your collision coverage handles the repair costs. Gap insurance has nothing to do with that claim.

Can I buy gap insurance after I've already bought the car?

Yes, if you buy it through your car insurance company. You can add gap coverage to your policy at any time. If you bought gap insurance through the dealership and want to cancel it, you'll need to refinance the loan or pay it off, since dealership coverage is tied to the loan itself.

What happens to gap insurance if I pay off my loan early?

If you buy gap insurance through your insurance company, you can cancel it once you've paid off the loan — you no longer need it because you won't owe more than the car is worth. If you bought it through the dealership, you may be able to get a refund for the unused portion, but this depends on the dealer's policy and your lender's rules.

Is gap insurance the same as loan/lease payoff coverage?

They're similar but not identical. Loan/lease payoff coverage is a broader product that may include gap insurance plus other protections. Gap insurance specifically covers the difference between what you owe and what the car is worth. Ask your insurance company what's included in each product they offer.

Do I need gap insurance if I'm paying cash for the car?

No. Gap insurance only makes sense if you have a loan or lease. If you own the car outright, you don't owe anyone money, so there's no gap to cover.