Gap Insurance

If your vehicle is totaled or stolen, gap coverage (also known as gap insurance) is an optional coverage that helps pay off your existing auto loan. 

What is gap insurance and what does it cover?

Gap insurance covers the difference between what you owe your lender and your car’s actual cash value (ACV). If you owe $14,000 on your loan and your car’s ACV is only $10,000, this covers the “gap” between what you owe and your car’s value. In this case that would be $4,000, minus your deductible.

If you’re in an accident and your insurer declares your car a total loss, they’ll only pay out its actual cash value, minus your deductible. Without gap insurance, you’d either have to keep making loan payments or pay off the loan balance yourself—for a car you can no longer use. That’s pretty frustrating.

Gap insurance is usually an optional coverage, but sometimes a lender will require you to carry it if you’re leasing or financing a new car.

When do I need gap insurance?

While some dealerships sell gap insurance, you can also add it to your insurance policy. When should you consider buying gap insurance? 

• You bought a brand new car and made less than a 20% down payment
• The value of your car is significantly less than your loan balance
• You’re leasing a car and the lessor requires it
• You rolled negative equity from an old car loan into your existing loan
• The type of car you bought depreciates quickly
  

It’s hard to know your car’s current value, but resources like Kelley Blue Book are a good place to start. If you’re not sure if you need gap insurance, talk to your insurance company. They’ll help you determine if you’re ‘upside down’ on your loan—i.e., you owe more than the car’s ACV—and how much gap insurance coverage you need. 

What does gap insurance cover?

Most drivers choose to purchase both collision and comprehensive coverages when buying a car insurance policy for a new car.   If you’re in an accident covered under collision or comprehensive and your car is a total loss, your added gap insurance will apply in the same basic situations.

Collision coverage

Collision coverage pays out for your car if you’re in an accident with another car or object like a tree or guard rail. 

Comprehensive coverage

Comprehensive insurance covers other types of damage to your car—like hail, vandalism, or theft. 

How gap insurance works

Let’s look at a hypothetical example.

Nico bought a new Hyundai for $25,000 with a small down payment of $3,000. Her loan balance is $22,000. After six months, the value of the car has depreciated to $20,000, but Nico hasn’t made much of a dent in the car loan. 

Then winter hits. Nico’s driving on an icy Vermont road, and she wipes out and crashes into a farmstand selling maple syrup. No one is injured, thankfully, but Nico’s car is a total loss.

Nico’s insurer will only pay out $20,000 (the car’s actual cash value). Plus, she has a $2,000 deductible.

$22,000 loan amount – $18,000 insurer payout (actual cash value minus your deductible) = $4,000 you still owe to your lender.

Nico would have to pay a total of $4,000 to clear her loan balance on the totalled car. With gap insurance, the insurer will usually cover this gap, up to a percentage of the car’s actual cash value. If the gap insurance limit is 25%, the maximum gap the insurer would pay out would be $20,000 x 25%, or $5,000. So in this case, the full $4,000 needed to clear the loan balance would be covered.  

According to the Insurance Information Institute, a new car loses 20% of its value in the first year. When you’re early in the loan term, your loan balance is still high. Combined, these two factors make getting in an accident during your first year of owning a new vehicle very costly.

How much does gap insurance cost?

How much gap insurance costs depends on how big a gap you need to cover, as well as your deductible. If you bought an expensive car with a small down payment and selected a small insurance deductible, expect to pay more for gap insurance coverage. 

Car insurance companies base premiums on risk, so they’ll also look at your driving record, whether or not you’ve totaled a car before, and other factors when preparing a quote. If your insurance company thinks they’d have to pay out thousands of dollars in the case of a total loss on your new vehicle, you’ll pay higher premiums. 

Who sells gap insurance?

The car dealership may try to sell you gap insurance coverage when you pick up the keys to your new vehicle, but buying a standalone gap insurance policy like this usually costs more. You should always get a quote from your car insurance company. 

It’s typically cheaper as an add-on to your car insurance coverage rather than purchased separately. And if you bundle your Lemonade Car policy with renters, pet, or homeowners insurance policies you can get big discounts!

Some car insurance companies only issue gap insurance coverage if the car is brand new. This means that you’re the original owner, or have the original lease, and your new car is only two or three model years old. 

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A few quick words, because we <3 our lawyers: This post is general in nature, and any statement in it doesn’t alter the terms, conditions, exclusions, or limitations of policies issued by Lemonade, which differ according to your state of residence. You’re encouraged to discuss your specific circumstances with your own professional advisors. The purpose of this post is merely to provide you with info and insights you can use to make such discussions more productive! Naturally, all comments by, or references to, third parties represent their own views, and Lemonade assumes no responsibility for them. Coverage and discounts may not be available in all states.