What is GAP insurance?
GAP insurance is an optional type of car insurance coverage. When applied, it reimburses an insured driver for the amounts owed on their leased or financed car if it is deemed a total loss. In other words, if that car is damaged beyond repair (totaled) or stolen, and the driver’s maximum insurance payout falls short to cover what they owed on the loan, GAP insurance would step in to pay the remaining balance.
GAP insurance is usually sold by dealerships and financial institutions. Although it might be cheaper to get it from your insurance company, not all insurers offer it. It might also come with reduced coverage compared to what a lender would provide. The ideal choice will largely depend on your budget and how you perceive risk as a driver.
Note: GAP insurance doesn’t apply if you’ve bought your car outright. That’s because there’s no gap to insure. The moment you acquire full ownership, the car no longer belongs to the lender, so your GAP insurance won’t have anything to cover. If the car is totaled or stolen thereafter, you’ll only be reimbursed for what the car is worth, provided it doesn’t exceed your policy’s limits.
To obtain GAP insurance, you’ll need to have some form of existing insurance on your car. Most leaseholders and lenders require that your policy includes both Collision and Comprehensive coverage for the duration of the lease or loan.
Also, it’s important not to confuse GAP insurance with a limited depreciation endorsement. While both do cover leased and loaned cars in the event of a total loss, a limited depreciation endorsement removes the insurer’s right to deduct depreciation from the value of the car when settling a claim. That means you’d be reimbursed for the car’s original purchase price. On the other hand, GAP insurance waives your responsibility to pay for what you still owe if the insurer’s claim payout doesn’t cover its full amount.
How does GAP insurance work?
Before we dive into the nitty-gritty of GAP insurance, it’s important to understand how claims on a totaled or stolen car generally work.
For a total loss, most standard car insurance policies only provide coverage up to the car’s actual cash value (ACV) — what it would be worth had the loss not occurred. The unfortunate reality about cars is that they depreciate quite quickly, especially newer ones. The moment you drive a car off the lot, you can expect it’s already lost about 10% of its value — up to 20% in the first year alone. Over time, the car’s value will only depreciate further with usage, meaning you’ll increasingly owe more to the lender than the car was originally worth.
So how does GAP insurance work in this situation?
Say you finance a car that’s retailed at $35,000. You made a down payment of $5,000, so you’ll finance the remaining $30,000 over a loan term of 48 months (4 years). A year later, your car is wrecked in an accident and your insurer deems it a total loss (or write-off).
After evaluating the damage, your insurer determines its depreciated value (ACV) is now $20,000. Since you still owe $22,500 on the loan after the first year (assuming yearly payments of $7,500), your insurer will pay the lender the first $20,000, while you’d be responsible for paying out of pocket for the remaining $2,500. However, if you have sufficient GAP coverage, it’ll pay for that balance instead, saving you from the financial burden.
Who should consider GAP insurance?
We’ve established that GAP insurance only applies to drivers with a leased or financed car. However, there are a few other scenarios where it might be beneficial to consider this extra coverage, such as if you’re:
- financing or leasing a new car where the model year is no longer than three years old.
- financing a car with a small down payment (less than 20%), or none at all.
- financing a car with a long-term loan, typically more than 60 months (five years).
- financing or leasing a luxury car that’s expected to depreciate faster than average vehicles.
- trading in a financed or leased car with an ACV above the outstanding loan balance.
In each scenario, having GAP insurance makes sense since the car’s depreciated value likely hasn’t exceeded the outstanding loan balance yet.
Also, since you’re adding extra coverage, keep in mind that GAP insurance could increase your car insurance premium.
Does GAP insurance cover used cars?
Yes, GAP insurance can cover used cars that were leased or financed if the unpaid portion of the lease or loan exceeds the car’s depreciated value (ACV).
For example, let’s say you finance a $20,000 second-hand car over four years with no down payment from a used car dealership. A year later, the car is totaled and you still owe $15,000 (from having paid $5,000 in the first year). The insurer determines the car’s depreciated ACV is now $12,000.
In the claim settlement, your insurer pays $12,000 to the dealership to cover your car’s ACV. GAP insurance would then pay for the remaining $3,000 balance you owe.
Had the insurer valued the car’s ACV at $17,000, GAP insurance wouldn’t apply. In this case, since the payout exceeds the amount you owe, the insurer would offer you the extra $2,000 as a cash settlement.
As mentioned previously, cars can depreciate by up to 20% in their first year alone. That’s why some insurers will only offer GAP insurance on a used car if it is less than three years old.
If you’re still unsure about whether GAP insurance is right for you, consider consulting with your dealer, financing company, or insurer.
