What Is Auto Gap Insurance and What Does It Cover?

Heading to the dealership to pick up your new set of wheels makes for one awesome day! Whether you decided to finance your new car, lease it or purchase it outright, the decision is entirely up to you. Either way, you’ve worked hard to secure the finances needed to make that car purchase a reality. To protect your investment, and since you’re a responsible driver, you probably have collision coverage to cover the cost to replace your car if you get into an accident and your car is totaled.

However, collision coverage is only going to pay out the actual cash value of your vehicle — in other words, the “fair market value” — which is often less than what you still owe on your car.

When the amount you’re paying for your car is more than the car’s fair value, this creates a gap in your coverage — and you cover this financial gap out of your own pocket.

But fear not! This is where gap insurance comes into play so you won’t need to worry about additional out of pocket expenses. Lease and loan gap insurance helps pay the difference, so that in the event of a total loss, you won’t be left to cover that potential hefty bill all on your own.

Let’s take a closer look to see if you need gap insurance and how gap insurance can help financially protect you.

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Do I Need Gap Insurance?

First and foremost, do you lease or finance your car? That’s usually a good determining factor in whether you should have gap coverage or not but leasing or financing your car doesn’t always mean you need this coverage.

Here are some ways to determine if you need gap insurance:

The value of your car depreciates quickly. If you end up getting into an accident on the way home from the dealership, you could be upside down (which is when you owe more than what the car is worth) within minutes of your new purchase! Not good. Insert gap insurance — this will help cover that cost you still owe after your insurance pays for the actual cash value of your vehicle if it’s deemed totaled.
Since this coverage only protects you when you owe more than your car is worth, if you’re at a point in your payment plan where you owe less than what your car is worth, then gap insurance doesn’t do much for you. Just make sure your loan balance consistently stays below the actual cash value of your car if you decide to forgo gap coverage.
Were you only able to make a small down payment when you got your vehicle? Now is an important time to have gap coverage, since you probably have a sizable outstanding loan.

Assuming the value of your car is going to be less than what you owe on your loan, gap insurance can protect you from a substantial payment — maybe thousands of dollars. On that note, it’s smart to have gap insurance if you have a new or expensive vehicle, since your investment is worth more.

What Does Gap Insurance Not Cover?

Though having gap insurance coverage can be a financial life saver in the event you were to total your car and still have your lease or loan to pay, don’t confuse its purpose — here’s what gap insurance does not cover:

If you’re having trouble making your car payments due to a financial hardship, disability, loss of job, etc.
Any repairs to your vehicle
The carry-over balance on a loan you may have rolled over into your new car loan
Paying for a rental car while your vehicle is in the shop
Extended warranties added to your car loan
A down payment for a new car
Reduced value of your car after an accident

Simply put, lease and loan gap insurance coverage protects you from being put in a situation where you have to pay the difference out of your own pocket (for a vehicle you no longer can drive!), while also having to pay for another vehicle, too.

How Does Gap Insurance Work?

Here’s the deal — when you drive your vehicle off the dealership lot, according to Edmunds.com, its value depreciates around 11 percent, meaning your car is already worth less than what you just paid for it only minutes ago.

Here’s an example of how gap coverage works:

You buy a car for $30,500, make a $500 down payment and take out a $30,000 loan with monthly payments of $400.
Now, imagine four months later you get into an accident and your car is totaled. Your insurance company decides the actual cash value of your vehicle, or the fair market value, is $26,000. They’ll pay this much (minus the deductible) through your collision coverage on your insurance policy.
However, because of the structure of your loan payment, you still have $29,500 to pay on the loan, leaving a gap of $3,500. Without gap insurance, you’d be responsible to pay that entire difference. However, with gap insurance, you’re only responsible for the $500 deductible.
Having gap insurance eliminates this deficit, since your insurance company will also pay that gap of $3,000.

Do I Need Gap Insurance on a Lease?

Gap insurance works similarly whether you lease or finance your car. As stated before, the value of the car depreciates the second you take it off the dealership lot. So, the market value of your leased car is going to be much lower than what is still owed on your lease contract.

If you total the car, you’re responsible for the fair market value of the vehicle and what you still owe on the lease, a.k.a. — the gap. So, your insurance company will pay the actual cash value of your leased car, but you’ll pay for that gap, which could be in the thousands!

Some things to keep in mind about gap insurance for your leased car:

Gap insurance is extra important for those leasing a car, and that’s why a lot of leasing contracts include gap insurance by default. Before you purchase gap insurance, check to see if it’s already included by either the leasing company, dealership, or the car leasing insurance company.
If you lease or finance your car, your dealership will typically require that you have comprehensive and collision coverage, and once you purchase these you can also add the gap coverage.
Your deductible is usually not covered by gap insurance, but some plans do cover the deductible, so be sure to check with your provider.
You may have to continue paying your lease payments until your insurance claim is completely settled.

Does Gap Insurance Cover Theft?

To get the benefits of gap insurance if your vehicle is stolen, your auto insurance company will have to declare the vehicle a total loss. This happens in two ways: if your vehicle is recovered with enough damage done to it by the people who stole it, or if your vehicle is never recovered — usually, insurance companies will have a waiting period to allow time for your car to show up.

If your insurance company does declare your car a total loss, they will pay out the fair market value of the vehicle, which sometimes is less than what you still owe on the vehicle, even if it were stolen. So, if you total your car, and have a “gap” to pay, you may have that same gap to pay for if your car was stolen.

Keep in mind, every insurance company is different, and though most cover theft with gap insurance, you’ll want to check to see how a stolen vehicle is handled with your specific provider.

Is Gap Insurance Required?

Is gap insurance mandatory? In most cases, no. Typically, the only time gap insurance is required is if you lease or finance your car, where it will be included in the contract and you’ll commonly pay for it within the lease agreement for a fee. Other times, you probably won’t be required to have the coverage. Be sure to check with your dealership and ask if it’s included.

But just because you might not be required to have gap coverage doesn’t mean you should forgo it completely! Gap insurance only adds a few more dollars to your monthly or biannual policy, but it could save a big chunk of money in the long run.

How to Get Gap Insurance

You can purchase gap insurance right at the dealership, but it can be less expensive if you purchase it from an insurance company. Check with your agent to see how much it would cost to add the coverage to your policy.

Remember, if you lease your vehicle, the coverage may already be included in your lease contract, so ask your dealer if you’re protected and how much you’re paying for the coverage.

Now that you know some important reasons you might need gap coverage, connect with an American Family Insurance agent and visit our page on lease/loan gap insurance — your agent can help you add this smart coverage so you’ll be protected from the unexpected.

This article is for informational purposes only and includes information widely available through different sources. This article does not afford or guarantee coverage.

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