Gap Insurance: What Is It and Do You Need It?

2012 Chevrolet Camaro ZL1 crash damage
If you crash your new car, gap insurance can save you money. Photo © Aaron Gold

Gap insurance covers the difference (the gap) between what your vehicle is worth and how much you owe on the car. Gap insurance comes into play if your car is stolen or totaled (damaged to the point that repair would cost more than the car is worth) before the car is paid off.

How Gap Insurance Works

Let's say you buy a new car for $20,000. You put $500 down and your payments are $350 per month. Six months after buying your car, it is involved in an accident and totaled.

 

The insurance company determines that your six-month-old car is now worth only $15,000. They will pay you that amount (less your collision deductible if the accident is your fault). You've made six monthly payments plus your down payment, for a total of $2,600; you still owe $17,400 on the car. In a case like this, gap insurance would pay the $900 difference between what collision insurance covers ($15,000) and what you owe on the car ($17,400). If you did not have gap insurance, the extra $2,400 would come out of your pocket. (Note however, that if your insurance company determines that your deductible applies, paying the deductible is your responsibility -- gap insurance won't cover it.)

Gap Insurance and Leasing

In the case of a lease, even though you aren't buying the car outright, you are responsible for the cost of the car if it is stolen or totaled. Because lease payments tend to be significantly lower than purchase payments the difference between what you have paid and the value of the car can be a substantial amount of money.

Therefore gap insurance is much more critical for a lease. In fact, many lease contracts require gap insurance.

Gap Insurance and Financed Purchases

For buyers, gap insurance only makes sense if you expect to be "upside down" on the car (a situation in which you owe more than it is worth). If you made a low down payment, if you bought a car that depreciates rapidly, if you have a high interest rate or if you rolled over other costs into your new car payments (such as money you still owed on car you traded in), gap insurance makes sense.

Most buyers, particularly those who made a healthy down payment, will always be right-side-up on the car, and therefore don't need gap insurance.

Who Should Buy Gap Insurance

People who are leasing a car or who expect to owe more than the car is worth for a significant amount of time should definitely buy gap insurance.

Who Should Not Buy Gap Insurance

Buyers who have arranged their down and monthly payments so as to ensure that they won't be "upside down" on the car for any significant period of time probably do not need gap insurance.