Gap Insurance on Used Cars: Do You Need It?

Buying a used car gets you into a vehicle for thousands of dollars less than buying new. Not only do you save on the purchase price, but you also avoid some of the depreciation that reduces a new car’s value by about 20% in the first year alone, according to Kelley Blue Book estimates.^[1]

However, used cars also depreciate, and if yours depreciates enough that you owe more on your auto loan than the car is worth, you could be out a lot of money if your car gets totaled or stolen. Guaranteed asset protection insurance — gap insurance for short — can help protect your investment.^[2]

Here’s what you need to know about gap insurance for used cars, and why it’s important to consider gap insurance when comparing car insurance quotes.

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How gap insurance works for used cars

Gap insurance is an optional coverage that bridges the gap between the amount you owe on your car and the car’s actual cash value, or ACV, which is typically what an insurer will pay out in case of a total loss.

If your car is stolen and never recovered, for example, your insurance will cover the loss, but only up to the car’s ACV. If that amount is less than you owe, you’ll have to pay off the remainder of the loan out of pocket if you don’t have gap insurance.

With gap insurance, your insurance will cover the loan balance that remains after your full coverage, less the deductible, pays you for your vehicle.

Is gap insurance worth it?

The most important thing to remember about gap policies is that you don’t need one unless you have a loan on your vehicle and the vehicle’s ACV might fall faster than the balance on your loan.

You may want to consider gap insurance if any of the following scenarios are true:

• You rolled the loan balance on a trade-in into the new loan and have negative equity as a result.

• The car is only a year or two old and is depreciating faster than it will in later years.

• You financed all, or almost all, of the purchase price.

• You have a longer-term car loan.

• The vehicle is an electric vehicle or luxury SUV or sedan. These vehicles generally depreciate faster than other model types.^[3]

Gap insurance real-world example

To understand how gap insurance can benefit you, take a look at these hypothetical scenarios.

First, let’s say you purchase a used vehicle for $30,000 and finance the entire purchase price, sales tax, and fees, using a 72-month loan. These fees add $3,600 to your purchase and bring your total loan amount to $33,600.

A month later, before you’ve even made the first payment, you have an accident that causes serious damage to the car.

After factoring in depreciation, your insurer determines that your car was only worth $29,000 at the time the accident occurred. Because the damage is so extensive, your insurer declares the car a total loss and opts to reimburse you for the ACV rather than pay for the cost of repairs.

The collision coverage on your auto insurance policy reimburses you $28,500 — the full $29,000 cash value less a $500 deductible. You use the claim money to pay off $28,500 of the loan and pay $500 out of pocket.

However, after this payment, you still have a loan balance of $4,600. This amount represents the gap between your car’s ACV and your loan amount. If you have gap insurance, your policy will cover this amount so that your loan is paid in full.

Now imagine this same scenario, only this time you make a $10,000 down payment when you buy the car and pay taxes and fees out of pocket instead of rolling them into the loan. You only need a $20,000 loan in this case.

Imagine again your new car gets totaled a month later and your insurance company pays you $28,500 — the full $29,000 actual cash value of your vehicle minus the $500 deductible.

In this case, you could use the money to pay off your $20,000 loan and have $8,000 to put toward another car.

In this latter scenario, gap insurance would have been a waste because the car was worth substantially more than the loan balance. Therefore, there was no gap to be reimbursed.

How to get gap insurance

While the dealership where you buy your car might offer you gap coverage, you’ll likely pay a higher price for it because dealerships generally bill gap insurance as a flat, one-time fee. If you roll the coverage into your loan, you’ll also pay interest on it because the fee will be included in your monthly payment.

Usually, a better solution is to add gap coverage to your current car insurance policy through a private insurer. If your insurer doesn’t offer gap coverage or you’d rather go elsewhere, you can change insurers and add it to your new policy. The gap insurance cost is nominal when added to an auto insurance policy, and you can cancel it when you no longer need it.

Wherever you purchase coverage, be sure to check the fine print for information about any coverage limits and exclusions.

Gap insurance vs. full coverage: What’s the difference?

A full-coverage policy and gap insurance coverage serve different purposes. Instead of competing, gap insurance picks up where full coverage leaves off.

Full-coverage insurance covers damage to your car caused by a collision or other covered event. If your car is worth $20,000 and you total it in a covered event, full coverage would reimburse you $20,000, less your deductible. Full coverage also pays for injuries and damage you cause in an accident.

Gap insurance, on the other hand, covers the difference between the value of your vehicle and the car loan balance if your insurance company determines the car is a total loss and you owe more than the car is worth.

For example, if your $20,000 car has a $25,000 loan balance, full coverage would reimburse you the $20,000 (less deductible), which you’d use to pay down the loan. Gap insurance coverage would then repay the remaining $5,000 loan balance.

Alternatives to gap insurance

Gap insurance isn’t the only way to cover a gap between the actual cash value of your car and the amount left on your auto loan. The following alternatives might be worth exploring:

• Loan or lease payoff coverage: Loan/lease payoff coverage isn’t insurance, even when it’s offered by an insurance company, though some companies do offer it in place of gap coverage. While loan/lease payoff coverage pays your loan via direct payment to the lender, the coverage is limited to a percentage of the car’s value, like 25%, for example.

• Collateral exchange: If you opt not to get gap insurance and your car is declared a total loss, your lender might allow a collateral exchange to help you repay any remaining loan balance. To do this, the lender extends the existing loan to the new vehicle you purchase and adds on the original loan’s balance.^[4]

• Debt cancellation: Whereas gap insurance is actually insurance and regulated as such, the coverage car dealers offer is often a similar product called a debt cancellation agreement or debt waiver.^[5] These financial products aren’t insurance products, and you may be asked to pay fees relating to the debt cancellation process.

Gap insurance on used cars FAQs