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How to Tell if You Need Car Gap Insurance

How to Tell if You Need Car Gap Insurance

In the context of insurance, gap is an acronym which stands for Guaranteed Auto Protection or Guaranteed Asset Protection (depending on who’s answering), and typically comes into play when insuring a new car. Gap insurance covers the difference between what is owed on your car and what the insurance company may pay out in the event of an crash or loss. For example, if you owe $30,000 on your car but the value of the car is estimated (perhaps by the Kelley Blue Book) at only $25,000, this difference of $5,000 would be covered by your gap insurance. Gap car insurance will pay the difference between the actual cash value (ACV) of the vehicle and the current outstanding balance on your loan or lease. Sometimes it will also pay your regular car insurance deductible.

Gap insurance originated during the early 1980s to help those who purchased a car and found themselves owning more than the car was worth if it was in a total loss situation (due to the rapid depreciation of the car).

Although gap insurance is not required by law, most banks or lending institutions require it in order to fund the loan on the car. As with any insurance, it is usually better to err on the side of caution and invest in some gap insurance. It’s also not uncommon for lease contracts to have gap insurance included in them. Sometimes it's referred to as auto loan/lease coverage or loan/lease payoff coverage.

If a lender of leased cars requires gap insurance to be purchased, then they must include the gap insurance within the cost of the lease itself. This means that the monthly price quoted by the dealer must include gap insurance when they mandate you carry this coverage.

There are some financial institutions that may want you to have gap insurance as part of your auto insurance policy on the car you are purchasing. If this is the case, your loan or lease papers should note this.

If you have declined gap insurance, a dealer shouldn’t be able to add it onto your loan amount or charge you for it in another way. Even though gap insurance may be helpful to you, if you owe more on the vehicle than its ACV and were to be in an accident, you should have the right to turn down this coverage and not be charged for it.

Typically, when a car is totaled by a covered peril, such as a crash, fire, or vandalism your insurance company will pay you the actual cash value for your car (if you have comprehensive and collision insurance). Often, this amount is less than the actual amount you still owe on your loan or the amount due for a lease payoff.

When the amount of your ACV payout is less than what you owe on your lease or loan, the loss from this financial shortfall is the "gap" you will be left owing.

For example:

  1. You buy a car that costs you $30,000 and you drive it home
  2. After paying the down payment you owe $25,000 in car payments over five years You purchase physical damage insurance (comprehensive and collision) with a $500 deductible to protect you against damages and loss
  3. You have an accident while you are still upside down on your loan or lease (meaning you owe more on a car than it's worth) and your vehicle is totaled
  4. The insurance company determines that the actual cash value of the car is only $25,000, but at the time of the loss you still owe $22,00
  5. Gap insurance should pay the difference plus your deductible, totaling $2,250 (although not all gap policies pay the deductible)

As car owners know, the value of a car steeply drops off as soon as it’s driven off the lot. So if you owned the car for three days, had physical damage coverage and the car was totaled, you could owe 10 to 20% of the $30,000 ($3,000 to $6,000 out of your pocket) even though you purchased "full coverage."

Car owners often mistakenly assume that if their car is totaled, it will be replaced at the amount they paid, or at least the amount they owe, which is is why many car insurance companies offer gap insurance (loan/lease payoff insurance) as an optional coverage that is available with physical damage coverage.

If you buy gap insurance from a car insurance company, it typically costs about $20 a year, according to the Insurance Information Institute, a trade group. Most insurers will add gap insurance to your comprehensive and collision coverage, so you'll usually have to buy that coverage as well.

Typically, a stand-alone gap policy sold by a car dealer is much more expensive. Lenders typically charge between $500 and $700, according to United Policyholders, a nonprofit consumer advocacy group.

Even if you get gap insurance, you still need your state's minimum auto insurance coverage (the insurance coverage that police check if you are stopped and asked for your insurance card), because gap insurance isn’t catch-all coverage.

While most states require you to have certain car insurance coverages, typically at least bodily injury liability and property damage liability, for your gap insurance to be in effect you need to carry physical damage coverages of collision and comprehensive on your vehicle as well. This "full coverage" of liability and physical damage coverages is also normally required by your lien holder.

Essential tips about gap insurance

  • Being late with your car payment won’t void your gap insurance policy. Getting behind on your car loan doesn’t automatically cancel out your gap insurance, but it does mean that if you total your vehicle before you catch up, your gap insurance won’t pay out for the late payments.

  • Gap insurance usually pays out the difference between your wrecked car’s ACV and the remaining balance due to your lien holder on your car loan. But there are exceptions and conditions to gap policies for certain items, such as late car payments.

  • If you have overdue payments or were granted a payment holiday so that some payments were moved to the end of your loan, this amount wouldn’t be covered by your gap insurance policy. If had you paid on time these monies would not have been due at the time of the total loss.

  • Gap insurance will not cover your car if it's declared a total loss but your claim is denied for coverage or if you did not have primary insurance coverage on the vehicle at the time of the accident.

  • You can buy gap insurance on used cars. State laws and insurance companies’ guidelines vary, but there are gap policies that are available for used cars that are financed. Gap insurance is beneficial when the value of a vehicle, whether new or used, depreciates while you still owe money on the loan or lease.

  • You cannot get gap insurance for lines of credit that may be used for purposes other than a vehicle. Gap insurance doesn’t work with mortgage loans, credit lines, balloon payments or other types of non-vehicle specific loans.

  • If you have used money from your Home Equity Line of Credit (HELOC) to purchase your car, gap insurance would not cover this type of loan since the HELOC is not specifically to be used for a vehicle loan.

  • Gap insurance providers won’t offer coverage if your loan is through a private individual instead being a structured loan from a proven financial institution, such as a bank or finance company.

  • With a private party loan it is hard for the gap carrier to be know that the loan is only for the vehicle, and that payments were made on time requires.

  • Gap insurance isn’t accepted by any Department of Motor Vehicles as proof of insurance. It’s not the right type of insurance needed to show financial responsibility when you are going to register, or renew registration, on your vehicle.

  • Gap insurance cannot be transferred to a different vehicle or loan. If you are trading in, selling, or buying a new vehicle, you will need to get a new policy to cover the newly financed vehicle.

  • You won’t get a refund for your gap insurance if you pay off the car or trade it in. If you financed your vehicle and the gap insurance is part of your vehicle's financed monthly payment, then you probably won’t receive any refund for your gap insurance. That is because when the coverage gets paid for monthly – as part of your financed monthly payment – then the coverage is used that same month.

  • If you paid for your gap insurance policy in full, then you will need to contact the company that sold you the policy to see if there is any unused premium that should be refunded back to you when you trade in or pay off your car.

  • If you put down a decent down payment, your vehicle depreciates at a steady pace, and you are paying down the balance of the loan each month, then typically you wouldn’t need gap insurance coverage.

  • Gap insurance is only needed if you have negative equity in your car (owe more than the value of the vehicle) since this coverage only pays for the balance of the loan left after the ACV is paid out when your car has been found to be a total loss by an insurer. If you owe less than the value of your vehicle, then save your money; you don’t need to buy gap coverage.

  • Gap insurance does not normally come with a deductible attached to it. Some policies pay the deductible and some don't. When gap insurance pays the primary insurance deductible amount, the deductible amount is not actually reimbursed back to you. Instead, the primary insurance deductible is taken from the payout of your totaled vehicle and covered as part of your unpaid loan balance, which gap insurance pays.

What’s not covered by gap insurance

Gap insurance usually won’t pay for:

  • Overdue lease/loan payments
  • Costs for extended warranties, credit life insurance, or other insurance purchased with the loan or lease
  • Carry-over balances from previous loans or leases
  • Financial penalties imposed under a lease for excessive use
  • Security deposits not refunded by the lessor
  • Amounts deducted by the primary insurer for wear and tear, prior damage, towing, and storage
  • Equipment added to the car by the buyer, meaning that only factory-installed equipment is covered
  • Mechanical issues, such as engine or transmission failures, or any other car problems that are not losses covered by your car insurance policy

How to cancel gap insurance

If you no longer want your current gap insurance policy because you believe you paid too much for it, then shop around to see if a cheaper policy is possible. If it is, then see about canceling out your current one before buying the new one.

You can cancel gap insurance if you no longer need it. If you just purchased the policy, it may be possible that if you cancel within a certain time period (typically 30 days) you can receive a full refund. A cancellation fee may apply.

If you cancel the policy after the initial period you’ll probably receive a refund prorated according to the length of time that you kept the policy in effect. You can’t get a full refund since you’ve “used” a portion of it already.

If you’re still upside-down on your car’s loan (owe more than it’s worth), then gap insurance is likely still needed. If you now owe less than the car's ACV, you could cancel your gap insurance since it would not pay out if your car were totaled out by an insurance company after an accident.

If you bought your gap insurance through a dealership or finance company, you could find a policy with a credit union or auto insurance company for much less. Comparison shop for gap insurance, just as you would for the car insurance policy for a new car.

This article is adapted with approval from carinsurance.com: http://www.carinsurance.com/gap-insurance.aspx

The statements expressed above are only for informational purposes and should be independently verified. Please see our terms of service for more details
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