Understanding Gap Insurance and Its Importance
Insurance companies typically pay the depreciated value of your car if it’s totaled or stolen, which might be less than your car loan balance. This discrepancy is known as a “gap” between the vehicle’s value and the remaining loan amount. To address this issue, gap insurance can cover the difference, preventing you from having to pay thousands of dollars out of your pocket.
What Is Gap Auto Insurance Coverage?
Gap insurance pays the difference between the balance you owe on your car loan and the amount an insurance company will pay if your car is totaled. You can add gap coverage to your car insurance policy or purchase a gap waiver through the dealer when you buy a car. If you’re using a bank or credit union for your car loan, they might also offer gap insurance.
New cars tend to depreciate quickly, so you might owe more on your loan than the car is worth—especially if you didn’t put much money down when you bought the car or rolled over a balance from a previous loan.
Without gap insurance, you might have to pay thousands of dollars out of your pocket to pay off the loan if your car is totaled, which means less money to use to buy another car.
How Do Car Insurance Companies Value a Car When It Is Totaled?
When a car is totaled, insurance companies pay the depreciated value of your car immediately before the accident—what it would cost to buy a car of that age in your area with similar mileage, options, and other details. This is called the actual cash value (ACV) of the car. If you’re making a claim on your collision or comprehensive insurance, your deductible will be subtracted from the claim payment.
Insurance companies use internal car sale information databases to calculate the value of a vehicle when it is totaled, but you can use a website such as Edmunds, Kelley Blue Book, or J.D. Power and enter details about your car to estimate its current value.
When Should You Get Gap Insurance?
Consider getting gap insurance when your auto loan balance will exceed your car’s ACV, especially if it’s by a substantial amount. This might be the case if:
- You made a down payment of less than 20% when you purchased a new vehicle.
- Your car loan is for 60 months or longer. According to Edmunds, more than 22% of new car loans are for 84 months or longer.
- You rolled the balance from a previous car loan into a new loan when you traded in your old vehicle to purchase a new one.
- Your loan includes the cost of additional features or products, such as an extended warranty, wheel and tire protection, or undercoating, that don’t increase the value of your car for insurance purposes.
- You bought a type of car that depreciates quickly.
The gap is usually the largest in the first few months after buying the car, then gradually shrinks as the depreciation slows down and you pay down the loan balance.
Calculating Whether Gap Insurance Is Worth It
You can use a simple calculation to figure out if you have a gap and whether it’s worthwhile to get gap coverage when you buy a car and keep it after you start to pay off the loan:
- Use the appraisal tool at Edmunds or the my car’s value tool at Kelley Blue Book to estimate how much your car insurance company might pay if your car is totaled.
- Contact your car lender or look at your most recent loan statement to find out how much you owe on your car loan.
- Find out the gap insurance cost from your car insurance company and the car dealer.
- Decide whether it’s worth paying that extra amount to fill in the gap, and whether to get it from your insurance company or the car dealer.
If you know you want gap insurance, do some research before going to buy a vehicle. Find out the cost of gap insurance from your auto insurer or the bank or credit union that is doing your car loan. Then you can compare the cost with the gap insurance price from the dealer.
Gap Coverage Limitations
The gap insurance typically covers the difference between your vehicle’s actual value and the balance of your loan (minus any deductible), which changes over time. However, there might be limits to how much gap insurance will cover.
“Gap insurance from an insurer may be subject to a cap of 25% over the vehicle’s value,” says David M. Pooser, an associate professor of risk management and insurance at the East Carolina University College of Business.
Coverage may also be limited if you’re rolling the balance of an old car loan into a new one. Some insurers won’t cover the rolled over amount.
A gap waiver sold by a car dealer typically makes up the difference for the full amount owed. However, there might be a maximum dollar amount covered, such as $50,000, says Tom Keepers, executive director of the Guaranteed Asset Protection Alliance, a trade association of companies involved in the gap waiver business.
Find out from your insurance company, bank or credit union, and car dealer whether there are any limits to the gap coverage they sell.
When Does It Make Sense to Drop Gap Coverage?
Run the calculation every year to reassess whether or not it’s worthwhile to keep gap insurance. The gap usually gets smaller over time, as the depreciation slows down and you pay off more of the loan.
If you have gap coverage through your insurer, you can drop it when you renew your insurance policy. You might also be able to drop it in the middle of a policy term and get a prorated premium refund from the day you remove the coverage, says Kate Ferri Dawson, owner of Ferri Dawson Insurance Group, an independent insurance agency in Murraysville, Pa.
Before dropping gap insurance, check your auto loan or lease agreement. You might be required to keep it.
Cost Considerations
Gap insurance costs depend on several factors, including whether you purchase coverage from an insurer, bank or credit union, independent gap insurance provider, or through the dealership.
The cost to add the coverage to your car insurance is usually low, though specifics vary by insurer and state. Ferri Dawson says it usually costs $45 or less per year to add gap insurance with the auto insurance companies she works with.
Car dealers typically charge a lump sum for gap coverage and roll it into your loan, which means you’re paying interest on the gap coverage in addition to the cost of the car. The average gap insurance costs a total of $650 to $695, with most programs capped at $999, says Keepers. The cost can vary based on the amount financed and other factors.
Gap Coverage From an Insurance Company vs. a Car Dealer
Cost isn’t the only way gap coverage might be different when purchased from an insurer vs. a dealership. Compare the costs and coverage from both sources before buying a car to ensure you choose the best option.
FAQ
Can I get gap insurance for a used car?
Yes, you usually can buy gap insurance for a used car, although some insurers will only offer gap coverage for cars that are less than a certain age, such as three years. You might be able to get a gap waiver from a car dealer for an older car.
Even though the used car started to depreciate before you bought it, you might still have a gap between the car value and the loan balance if you didn’t put much money down, you rolled over negative equity from another loan, or you have a long loan term.
Why does gap insurance from a dealership cost so much more?
When you buy gap insurance from a car dealership, called a gap waiver, the full cost is added to your loan in a lump sum and then included in your loan payments. The cost of gap insurance added to a car insurance policy, on the other hand, is only for that policy term, which is usually six months or a year.
If you add a gap waiver to your car loan, you will have to pay interest on the payments, which increases the cost. Find out from the dealer whether you can drop the gap coverage early and get a refund for the extra cost after the gap shrinks over time.
What happens if the gap exceeds my gap coverage limit?
Some gap insurance policies will only pay up to 25% more than the car’s value, or they might not pay for any balance you rolled over from a previous car loan. If the size of the gap is larger than your maximum coverage, you’ll have to pay the difference out of your pocket to pay off your loan.
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