What is GAP Insurance: Everything You Need to Know

By Jennifer Brozic 03/04/2022 4:00pm

Gap Insurance: What is is and why you need it.

You’re about to sign on the dotted line for a new car purchase or lease, and suddenly, the sales rep asks if you need GAP insurance for the vehicle. While GAP coverage can be helpful in some situations, it isn’t required by law, and it’s not always necessary. Here’s what you need to know about how it works, why you might need it, where you can buy it, and if it’s worth purchasing.

What is GAP Insurance?

GAP, which stands for guaranteed asset protection, is optional insurance you can buy when buying a car. It helps cover the gap between what you owe on your auto loan and your car’s actual cash value if it’s stolen or declared a total loss. You typically need to maintain comprehensive and collision coverage if you want to purchase GAP insurance.

How Does GAP Insurance Work?

Car values depreciate quickly, and if you finance your purchase, you may find yourself upside down on your auto loan, meaning you owe more than the vehicle is worth. However, if your car is stolen or totaled, your standard auto insurance policy will only pay the vehicle’s actual cash value at the time of the incident. It doesn’t usually cover what you paid for the car or what you still owe the lender. GAP insurance covers the difference between the insurance payout and the remaining balance on your loan or lease.

Why Do I Need GAP Insurance?

GAP insurance can help protect you from a financial loss if your car is totaled or stolen before your loan or lease is paid off. Here’s how. If the balance is higher than the vehicle’s value, you’re on the hook for the difference. A GAP policy helps pay for the difference between what your standard auto policy pays and what you owe the lender. So, you don’t have to.

When You Might Need It

Here’s an example of how GAP can help reduce your out-of-pocket expenses if you owe more than your car is worth.

Let’s say you owe $20,000 on an auto loan, and your vehicle’s current fair market value is $16,000. If your car is stolen or totaled in an accident, your insurance company will cut you a check for $16,000, and you’ll have to come up with the extra $4,000 to pay off your loan. But if you have GAP insurance, it helps cover the $4,000.

However, there are some exceptions. Georgia, for example, allows drivers to claim the diminished value of their car after an accident. That’s the amount of money you’d lose if you decided to sell your car since most people don’t want to buy a vehicle that’s been in an accident.

In states that allow diminished value claims, you typically must be able to prove the vehicle’s post-accident value (after repairs) is less than its pre-accident value. However, most states don’t cover diminished value claims if you were at fault for the accident.

Check state laws where you live before buying GAP insurance to know if it’s right for you.

Where to Buy GAP Insurance

If you want to purchase GAP insurance, you have two primary options — the dealership or an insurance company. When you buy or lease a car from the dealer, they’ll typically ask if you want to add this optional coverage. If you don’t want to buy it at the dealership, you can purchase GAP insurance from a traditional auto insurance company. Many major insurers offer it, but some don’t. If you want to buy a policy, check with your insurer before buying your car to find out if it’s an option.

Person researching car insurance on laptop

Car Dealership vs. Insurance Companies

Buying GAP insurance from the dealer may be convenient, but it’s typically more expensive than getting it from an insurance company. When shopping for your safety net policy, it’s a good idea to compare multiple quotes before purchasing coverage.

If you opt for a policy from the dealer, you usually need to get it when you buy your car. If you purchase coverage from an auto insurer, you typically need to purchase it when adding your new car to your policy. In general, you need to be the original vehicle owner to add GAP coverage to your standard policy.

Do I Need GAP Insurance If I Have Full Coverage?

Maybe. But first, let’s explain what full coverage means. Usually, when someone uses the term, they’re referring to a combination of liability, comprehensive, and collision coverage.

So, suppose you have full coverage through a traditional auto insurer and a loan balance on a newly purchased car. Your policy won’t cover the entire balance if your vehicle is stolen or totaled and you owe more than it’s worth. The insurance company will only pay for the vehicle’s current market value.

If you finance a vehicle’s purchase and you’re worried you’ll be upside down on your loan, you may want to consider GAP coverage.

Is GAP Insurance Worth the Money?

It depends. If you’re buying a car with cash, have a sizeable down payment, or can afford to pay the difference between what your car’s worth and what you owe, you probably don’t need GAP insurance.

But the added expense may be worth it in some situations, such as when:

  • You put less than 20% down. Typically, new vehicles lose 20% of their value within the first year of owning them and continue depreciating after that. If your down payment isn’t large enough, you may find yourself upside on your auto loan.
  • Your vehicle won’t hold its value. Some cars depreciate more quickly than others. These days, sedans typically lose value more quickly than SUVs or trucks.
  • You have an extended loan term. A long loan term may help lower your monthly payment, but it can put your finances in a precarious situation. With an extended term, you build equity in your vehicle more slowly than you would with a shorter term. However, your car depreciates at the same rate.
  • Your loan or lease requires it. Some auto loans and lease contracts require you to have GAP coverage.
  • You drive a lot. If you put many miles on your car, it’ll depreciate faster than a similar car with fewer miles. GAP insurance helps cover the difference between what you owe and what the car is worth. It may not cover the entire gap in some cases, depending on how much it’s depreciated.

How Much Does Gap Insurance Cost?

The price of GAP insurance varies based on where you buy it. According to the Insurance Information Institute, adding it to your standard auto insurance policy through a traditional insurer may cost as little as $20 a year. Purchasing it from the dealer could cost as much as $400 to $700 a year, according to WalletHub.

When you buy a policy from the dealer, you can usually choose to pay the premium up front or add it to your loan. If you roll the cost into your monthly loan payment, you’ll pay interest on the policy price, increasing your cost even more.