Gap Insurance Explained

What is gap insurance? Gap insurance is an optional type of insurance coverage designed to close the “gap” between the cost of your vehicle and its actual value. Gap insurance (uncapitalized) refers to the actual “gap” between the cash value of your vehicle and the amount you paid.

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Rachel Bodine graduated from college with a BA in English. She has since worked as a Feature Writer in the insurance industry and gained a deep knowledge of state and countrywide insurance laws and rates. Her research and writing focus on helping readers understand their insurance coverage and how to find savings. Her expert advice on insurance has been featured on sites like PhotoEnforced, All...

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Leslie Kasperowicz holds a BA in Social Sciences from the University of Winnipeg. She spent several years as a Farmers Insurance CSR, gaining a solid understanding of insurance products including home, life, auto, and commercial and working directly with insurance customers to understand their needs. She has since used that knowledge in her more than ten years as a writer, largely in the insurance...

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Reviewed by Leslie Kasperowicz
Farmers CSR for 4 Years

UPDATED: Nov 12, 2020

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Last Updated: December 10, 2018

Gap insurance is a crucial type of car insurance coverage. Unfortunately, it’s also one of the least-understood types of car insurance coverage.

Today, we’re explaining everything you need to know about gap insurance, including how it works and whether or not it’s worth the added price.

What is Gap Insurance?

Gap insurance is an optional type of insurance coverage designed to close the “gap” between the cost of your vehicle and its actual value.

The reason we need gap insurance is because of something called actual cash value (ACV), sometimes mistakenly referred to as actual car value. Actual cash value is an insurance industry term that refers to the value of your vehicle in cash if you were to sell it today. If you were just involved in an accident, then your insurance company will reimburse you for the actual cash value of your vehicle at the time of the accident.

That’s where the “gap” occurs. Let’s say you bought a brand new truck for $50,000. You drive the truck off the lot and get into an accident the next week. You still owe $50,000 to the dealership for your new ride, but your insurance company states the ACV of your vehicle as only being $40,000. That’s because the value of a new vehicle declines immediately after you drive it off the lot. Once the car is out of the dealership’s hands, the value drops significantly – even though you paid $50,000 for the truck just a few days before.

The ACV of a new vehicle drops as much as 30% within the first three months of ownership. The moment you drive the new vehicle off the dealership’s lot, the value drops 5% to 10%. When you get into an accident and your car is totaled, this gap quickly becomes a problem.

This is the “gap” that gap insurance is designed to cover.

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How Does GAP Insurance Work?

Sometimes, GAP insurance is spelled capitalized as an acronym. “GAP” insurance refers to Guaranteed Auto Protection insurance. Gap insurance (uncapitalized) refers to the actual “gap” between the cash value of your vehicle and the amount you paid.

Both GAP insurance and gap insurance are two terms for the same policy.

Most car insurance companies offer gap insurance to new vehicle owners. It’s often recommended on a leased vehicle or financed vehicle. If you are financing a vehicle from the dealership, for example, then it may be in your best interest to buy gap insurance. Otherwise, if your car is totaled, then you might be left owing significantly more than you received from your car insurance company.

What Does Gap Insurance Cover?

Whether you call it GAP insurance or gap insurance, it covers the same thing: it covers the gap between the amount owing on your vehicle and the payout you receive from your car insurance company.

Do You Even Need Gap Insurance?

As with all car insurance debates, the decision on gap insurance is personal. It’s up to you to determine your individual level of risk aversion before deciding whether or not gap insurance is worth it.

Generally, if you’re driving a new vehicle and are worried about the gap between ACV and the amount owing on the vehicle, then it may be in your best interest to buy gap insurance.

However, if you’re willing to take on greater risk in exchange for a lower monthly payment, then you may want to avoid getting gap insurance.

Before declining gap insurance, think of the situations below.

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When You Need Gap Insurance

You buy a new car from the dealership. It’s the latest model. You pay $30,000 for the vehicle in cash today. You drive it off the lot and take it home. You have good car insurance coverage. However, three months after buying the vehicle, you get into an accident. Your car is totaled. In the three months since you purchased the vehicle, the value of the car has decreased 30%. The insurance company happily pays you compensation for the actual cash value (ACV) of your vehicle, which is $21,000 – regardless of the fact that you paid $30,000 for the vehicle just three months ago. You’re left with a $9,000 loss paid out of pocket.

Or, consider the situation when you’re leasing or financing a vehicle. Let’s say you buy a $55,000 truck with a $5,000 down payment. You finance the remaining payments over 48 months. You owe $50,000 on the truck. You drive the truck home and get into an accident six months later. Your insurance states that the actual cash value of your truck is only $40,000, even though you still owe $50,000 to the car dealership. You receive a check for $40,000 but still owe $10,000 to the dealership. You’re required to pay this $10,000 difference out of pocket.

Is Gap Insurance Worth It?

As mentioned above, it’s up to you to decide if gap insurance is worth it. Some drivers won’t buy a new car without gap insurance. Other drivers are comfortable skipping gap insurance.

Here are some of the important points to remember when deciding whether or not to buy gap insurance:

  • If you have a few thousand extra dollars saved away, it’s in your best interest to put that money towards a new car and reduced your auto loan; putting more money towards a down payment can help you avoid the need for gap insurance
  • Generally, it’s recommended that if you put 25% or more down on your vehicle, gap insurance may not be necessary
  • Gap insurance generally has the best return on investment for the first three years of your car’s life; if your car loan extends beyond three years, then you will want to check the car’s value versus the amount remaining on your own to decide if gap insurance is worth it
  • Gap insurance can help you avoid bankruptcy; if your new car gets totaled and you’re short on cash, then you might end up with thousands of dollars in debt
  • Gap insurance can give you valuable peace of mind; some drivers are willing to pay slightly extra today in exchange for guaranteed coverage in any situation

Ultimately, the value of your vehicle will reach a point where the difference between the actual cash value (ACV) and the amount owing (or the amount you paid) isn’t as significant. After three years of car ownership, for example, the bulk of your loan may have been paid off. In this situation, it may be okay to remove gap insurance from your policy because it’s no longer necessary.

What Are Gap Insurance Requirements?

Gap insurance is not required in any state in America. It’s an optional type of car insurance available at added cost.

Some car loans actually include gap insurance automatically. Your gap insurance payments are included in your monthly car loan payments. This is also common when leasing a vehicle: your lease payments may include gap insurance.

Some dealerships also give drivers the option to decline gap insurance. If you want to save money on your monthly car payments, for example, then you might decline financing today.

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Conclusion: How to Compare Gap Insurance Quotes Online

Gap insurance may already be included in your policy. If you’re leasing or financing a vehicle, then you might not need to buy extra gap insurance because you already have it.

In other cases, gap insurance can be added to your ordinary car insurance policy just like you add any type of optional coverage. Call your car insurance company or compare car insurance quotes online today to determine if gap insurance is worth the price.

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