What Is Gap Insurance?

Definition & Examples of Gap Insurance

Couple in a show room buying a new car
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GAP insurance is a type of car insurance that covers the difference between what you owe on a vehicle and what it is actually worth. It protects you from owing a creditor more than a car is worth in the case of theft or an accident that causes a total loss.

Learn more about when GAP insurance is and is not necessary.

What Is GAP Insurance?

GAP insurance is a type of temporary car insurance. It protects against a depreciation loss for a vehicle that is greater than the balance you owe a creditor on that vehicle.

GAP insurance isn't necessary for car owners who own their vehicle outright However, most people who purchase a vehicle do so with some type of financing. Depending on the amount and type of financing you use, the value of your car could go down faster than the rate at which you pay off your debt.

GAP insurance is a type of car insurance, but it is not the same as liability insurance. Liability auto insurance is legally required for drivers and usually covers:

  • Bodily injury liability
  • Personal injury protection
  • Property damage liability
  • Collision

GAP insurance coverage will pay the gap between what the car is worth and what you owe in the case of an accident or loss. This allows you to pay off the remaining balance of your car loan.

Alternate names: guaranteed auto protection insurance, guaranteed asset protection insurance, gap insurance, GAP coverage, gap coverage

How GAP Insurance Works

Standard car insurance does not pay what you owe on a car. Instead, it pays actual cash value, or ACV, unless specified otherwise. If you are expecting an insurance payout to cover the loss of your vehicle, this could be significantly less than the balance of your auto loan.

For example, you take out an extended loan on a car, then suffer a total loss accident a year after purchase. You would owe more than the insurance payout on the car is worth because most of the payments over the last year went straight to interest and the car has depreciated by a significant amount.

GAP insurance would cover the difference between the insurance payout and what you still owe to repay your auto loan. Without GAP insurance, you would have to come up with the remaining amount owed on your loan by yourself.

It is rare for a lender to require you to purchase GAP coverage in order to finance your vehicle. If you are told you must purchase GAP insurance, check your sales contract first to see whether this is true. If the requirement is not included in the contract, you cannot be required to purchase coverage.

Do I Need GAP Insurance?

GAP insurance is critical for some buyers but can be a waste of money for others. Do not let a car salesman or insurance agent pressure you into buying GAP insurance without first knowing whether it will benefit your particular situation.

GAP Insurance Recommended

New cars depreciate in value quickly. Just driving a new car off the lot can lower the value of a vehicle. A serious accident or theft of a new car shortly after purchase can put you in the position of owing far more than it's worth.

You may need GAP insurance if you have:

  • Car loans with a loan length 5 or more years
  • A car loan with a high interest rate
  • A new vehicle purchase with a low down payment
  • A leased vehicle

GAP coverage is often included in lease agreements.

In any of these situations, a total loss car accident leaves you with the possibility of owing more than what the vehicle is worth. If you don't have the cash to cover the difference, GAP insurance can protect you.

GAP Insurance Not Recommended

On the other hand, some people have no use for GAP insurance. If you don't have a car loan, you do not need GAP insurance. You likely can also skip GAP insurance if you:

  • Had a large down payment
  • Got an excellent deal on the car price
  • Have a short term car loan, usually three years or less
  • Purchased your car outright

GAP insurance often comes down to the financial stability of the purchaser and the type of loan you took out to purchase a car. If you have bad credit or no credit, you may end up with a loan that has high interest rates or other unfavorable terms. The worse the loan terms are, the more likely you will need GAP insurance.

If you do get GAP insurance, you won't need it forever. Once you own less than the value of the car, you can cancel your coverage. You can use tools like Kelly Blue Book to keep up with the value of your vehicle and determine when you no longer need GAP insurance.

Key Takeaways

  • GAP insurance is a type of car insurance that covers the difference between what you owe on a vehicle and what it is actually worth.
  • It protects you from owing a creditor more than a car is worth in the case of theft or an accident that causes a total loss.
  • Drivers who own their vehicle outright do not need GAP insurance.
  • You may need GAP insurance if you have a high-interest car loan, made a low down payment, have an extended loan length, or leased your vehicle.

 

Article Sources

  1. Maryland Insurance Administration. "GAP Insurance FAQs." Accessed Aug. 10, 2020.

  2. Consumer Financial Protection Bureau. "What Is Guaranteed Auto Protection (GAP) Insurance?" Accessed Aug. 10, 2020.

  3. Board of Governors of the Federal Reserve System. "Buying vs. Leasing: Gap Coverage." Accessed Aug. 10, 2020.